Private ruling: Subdivision and sale of land. Whether on income or capital account
Date of advice: 27 October 2016
Published: February 2017
Ruling period: Year ended 30 June 2016 | Year ending 30 June 2017 | 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 | Year ending 30 June 2023 | Year ending 30 June 2024
Date scheme commenced: 1 July 2015

Ruling: Q1: Will a capital gains tax (CGT) event A1 happen when you dispose of the individual lots? | A1: Yes | Q2: Will the proceeds from the sale of the individual lots be assessable under section 6-5 of the ITAA 1997 ('the Act')? | 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 own a parcel of land located in the State of X (referred to as 'the Land') which you have held since 19YY. Your intention at the time of acquiring the Land was to build your principal place of residence. However, the house was not built until 20ZZ. The Land has been used for private use and enjoyment, gardening and at various times to hold a few farm animals. The Land has never been leased or used to derive any assessable income. You own the Land outright and there is no mortgage on the Land. You have never been in the business of land development or real estate sales, and have been retired for more than 15 years. You and your spouse are both over 70 years of age and have very basic proficiency in spoken English. You state that the Developer approached your associate in relation to the Land with the proposal to develop the Land, subdivide it and sell it in vacant residential and commercial lots under a proposed Land Development Agreement (LDA). You have stated that you believe the proposed subdivision, development and subsequent sale of each developed lot is the most appropriate method and way to realise the maximum value of the Land. Under the terms of the proposed LDA, you consent to the Developer undertaking a staged sub-division of the Land to allow for residential or commercial lots to be created and then sold to facilitate realisation of the value of the Land. The proposed LDA ('the Agreement') include terms and conditions confirming certain rights, options, entitlements, obligations, restrictions, undertakings, including the following: ● development to occur as a staged sub-division and is expected to create a specific number of vacant lots; ● the Developer undertakes all 'Project Services' in relation to the project; ● the Developer must provide its own finance for the project/development costs and will not be permitted to use the land as security for any borrowings by it or related entities; ● the Developer will pay council rates and state government land tax obligations in respect of the land from the time of signing of the agreement through to the completion of the development; ● all correspondence between you and the Developer shall occur via your appointed representative who may convene a progress meeting with the Developer no more often than on a fortnightly basis; ● the Developer shall make all decisions in relation to marketing of the completed lots; ● the Developer is required to maintain appropriate public liability insurance in connection with the Land; and ● you remain the registered proprietors of the Land during the development.

Relevant legislative provisions: Income Tax Assessment Act 1997 ('the Act') Section 6-5 | Section 6-10 | Section 100-25 | Subsection 100-25(2) | Subsection 100-25(3) | Section 102-20 | Section 102-25 | Subsection 102-25(1) | Section 104-5 | Section 104-10 | Subsection 104-10(3) | Section 108-5 | Section 108-7

Reasons for decision: Detailed Reasoning - Will CGT event A1 happen when you dispose of the individual sub-divided lots?: Subdivision 104-A of the Act deals with the disposal of a CGT asset. Under the operating provisions of subsections 104-10(1), (2) and (3) of the Act, CGT Event A1 occurs if you dispose of a CGT asset or if a change of ownership occurs where your ownership interest is transferred to another person because of some act or event or by operation of law. The time the event occurs is when you enter into a contract for disposal, or if no contract exists, when the change of ownership occurs. We have taken into consideration your intention to enter into the Arrangement, which is based upon the Agreement as provided to the Commissioner of Taxation, for the purposes of the proposed subdivision, the creation and subsequent disposal of the lots. The Arrangement and the Agreement include terms and conditions creating certain rights, options, entitlements, obligations, restrictions and undertakings for the purpose of achieving your main objective of sub-dividing and developing the Land to create around XXX vacant residential and commercial lots at various stages and registering each lot, at the end of each completed development stage, with the Title's Office with the view of the eventual sale of each lot. Subsections 100-25(2) and 100-25(3) and Section 108-5 of the Act define CGT asset and provides descriptions of different classes of CGT assets. In your case, the various lots to be created under the Arrangement will come under the definition of CGT assets for the purposes of the Act. In order to confirm whether the asset is a CGT Asset and whether a CGT event has occurred, it would be necessary to identify the relevant asset and determine the point in time at which the CGT event may have occurred as a result of such actions and dealings. Specifically the point in time when a CGT event occurs is important for various reasons - in particular, for working out whether a capital gain or loss from the event affects your income tax for the relevant income year (Subsection 100-20(3) of the Act). As the Arrangement, if entered into, would create various CGT assets, it is necessary to identify the CGT event that would best represent your situation, as permitted under the provisions of sub-section 102-25(1) of the Act which provides that if more than one event occurs, the one you rely on would be that which best matches your situation. As the Arrangement provides for the creation, registration and sale of various lots at the completion of each sub-division stage, and each newly created lot is considered to be a CGT asset, the sale of each lot and the point at which it occurred is considered to be material in determining which CGT event is most applicable to your situation. As such, we conclude that a CGT event A1 will occur in respect of each of you as owners of the Land each time that you enter into a contract to dispose of your interest in each lot, under the Arrangement, pursuant to sub-sections 104-10(1) and 104-10(2) of the Act. | Detailed Reasoning - Fundamental principles regarding income and capital: The income tax law recognises two mutually exclusive concepts - revenue versus capital. Revenue, otherwise known as income, is generally taxed at full tax rates. In contrast, capital is generally taxed under the CGT regime, provided that the CGT asset giving rise to the capital gain, has been held for at least 12 months and not a 'pre CGT Asset' - with the exception being where the owner of the asset is a company - the taxable capital gain may be reduced by up to 50%. On the basis of your submission and additional information provided, the proposed lots to be created pursuant to the Arrangement would not be considered as 'pre CGT' assets, as the land was acquired after 20 September 1985. In general, profits from property sales will either be assessable as ordinary income under section 6-5 of the Act or statutory income under the CGT provisions pursuant to the application of sub-sections 6-10(1) and 6-10(2) of the Act. Taking into consideration your intent under the Arrangement and the content of the Agreements, it is necessary to determine the extent of your direct involvement in the planning, organisation and management of the activities, and your contractual obligations under the Arrangement as well as the scale and complexity of the sub-division project and the basis for the application of sale proceeds from the sub-divided Land. These are significant factors which influence the determination of whether or not the transaction involved a mere realisation of a capital asset, or a one-off profitmaking undertaking, or the carrying out of a property development business. A subdivision project like yours, involving an asset that has been held for such a long period and the subsequent sub-division and development of that asset for sale, would invariably fall under one of the above-mentioned categories for taxation purposes. These categories are mutually exclusive and not determined by choice. Rather, the factual circumstances specific to the particular sub-division project will dictate how the transaction is characterised. However, while they are mutually exclusive, it is possible for different categories to apply to the same piece of land at different times during the ownership period. While it is acceptable at law to allow owners of an asset held for a long term, to realise this asset in the most enterprising way, there is a point at which the activities of such sub-division projects would transition into being either a one-off profit-making undertaking or a property development business. In other words, there may be a point in time where the transaction effectively transitions from being of a capital nature to a revenue nature as a result of a change in the intent of the parties and the nature of the undertaking under the arrangement put in place by the owner/s. In order to reach a balanced and just conclusion as to whether the tipping point, distinguishing the capital and revenue scenarios is reached, the facts specific to each transaction must be discretely and closely examined. There have been several cases in which the courts have addressed the question of whether the proceeds from the sale of an asset are of a revenue or capital nature. The decision in each case depended on its own facts and was very often a matter of relevance and degree. The following cases have been considered in the process of determining the questions relating to your case; these decisions confirm the contention that the Arrangement should be on capital account and does not facilitate a profit-making undertaking or property development business: ● FCT v Myer Emporium (1987) 163 CLR 199 where the High Court noted that the intention or purpose of acquisition is highly relevant to determining whether an asset is of a capital or revenue nature; ● Williams v FCT (1972) HCA 31 where the landowner used an intermediary in dealing with the developer and did not carry out any works herself; ● Statham and Anor v FCT (1988) 89 ATC 4070 ('the Statham case') where the landowner did not participate in the development activities and marketing of the lots, and the development of subdivided lots was part of a very simple process to realise the value of the asset; ● Westfield v FCT (1991) 28 FCR 333 where the landowner entered into a transaction that fell outside the ordinary course of business. Accordingly, the basis of any revenue argument could only be determined by considering the means by which the profit was made; ● McCorkell v FCT 99 ATC 2199 where the taxpayer inherited land from his father and only considered selling the land upon reaching the age of retirement. The AAT held that the taxpayer was not carrying on a business, similar to the finding in the Statham case; and ● Casimaty v FCT (1997) where the taxpayer acquired land for use as his residence and for farming. Due to ill health, uneconomical farming and a depressed rural market, the taxpayer discontinued farming activities and tried unsuccessfully to sell the land to the State Housing Department. More financial problems led to further subdivision of 10 lots for which council required roads, water, fencing, and draining a creek. Properties were sold by a local real estate agent. It was held that the disposal transaction was of a capital nature. Generally, the more work that has been or is being done directly by the owner on the land, in consideration of the nature of such work, the more likely that a transaction would be capital in nature. Taxation Ruling 92/3 provides the Commissioner's view of the factors that will need to be taken into consideration to determine when a land sub-division project may tip over from being a mere realisation of a capital asset to a revenue undertaking. These factors include the following: ● the landowner's significant intent or purpose in buying the land and selling the subdivided lots; ● whether the sub-divided part of the land was the subject of a business or commercial transaction; ● the expenses involved in the sub-division and the amount of expected profits; ● the nature, scale and complexity of the sub-division; ● how the sub-division is or was being carried out and who has the responsibility in undertaking the different aspects of the sub-division and sale of lots; ● who is actually involved in carrying out of the sub-division and the relationship between that party and the landowner; ● the nature and scale of other activities that have been undertaken by the party who is carrying out the sub-division; ● the timing of the acquisition of the land and the sub-division activities; ● the various steps involved in the project. Having considered the above-mentioned factors in light of the circumstances relating to the proposed development of the Land and sale of the lots undertaken by you, the sale proceeds are considered capital in nature and thus will not be assessable as ordinary income under section 6-5 of the Act, because such proceeds result from a mere realisation of the maximum value of your asset in the most enterprising way with minimum direct involvement from you. However, any net proceeds from the sales are considered to be statutory income under the CGT provisions of the Act, and should be included in your assessable income pursuant to the operating provisions of sub-sections 6-10(1), (2) and 102-5(1) of the Act.