Private ruling: Property - subdivision - disposal - income v capital
Date of advice: 3 August 2016
Published: September 2016
Ruling period: Income year ending 30 June 2016; and | Income year ending 30 June 2017.
Date scheme commenced: 1 July 2015

Ruling: Q1: Will the profit from the sale of the subdivided blocks be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of the taxpayer carrying on a business of property development? | A1: No. | Q2: Will the profit from the sale of the subdivided blocks be treated as ordinary income under section 6-5 ITAA 1997 as a result of an "isolated transaction" carried out for profit and commercial in character? | A2: No. | Q3: Will the profit from the sale of the subdivided blocks be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: Information and documentation has been provided with this private ruling which should be read in conjunction with, and forms part of this ruling. You and your spouse purchased the Property before 20 September 1985. The Property is a bush block which has a land area of more than 2 hectares and is close to a city. The Property was zoned "Rural" at the time you and your spouse purchased it. The Property has been used as you and your spouse's main residence. You and your spouse have retired from your business in the nearby city and wish to move to a location closer to your children who are located in another city. The local council amalgamated with other councils a number of years after you and your spouse had purchased the Property (referred to as the Council). A number of years after the amalgamation, the Council adopted a new development plan for the area which included changes to the zoning of a large portion of land in the area in which the Property is located. The current zoning for the Property is "Emerging Communities" which allows the Council to determine the type of residential development and density they deem appropriate, taking into consideration existing and future planned infrastructure. Under the present zoning, the Council will only permit the creation of rural residential allotments within the maximum and minimum land areas as specified by it. You and your spouse have a strong belief in environmental protection and want to subdivide the Property into two blocks, with the larger block to be used as a wildlife habitat for as long as you and your spouse live, with the smaller blocks to be sold to fund the purchase of the new residence closer to your children. In accordance with the zoning of the Property, the Council will not allow for the creation of one allotment with the existing house as it would be too large. To make the subdivision of the Property viable, and to provide you and your spouse with enough funds to build your next home, the portion of the Property that will not be used for the wildlife habitat, and on which your house is located, will be subdivided into a specified number of blocks (the Project). The potential subdivided block on which the house will be located will be larger in size than the other subdivided blocks of vacant land. To allow for the intended subdivision of the Property, a new access road must be built to provide a new access to the house. An application for the Development Application was lodged with the Council with a decision notice being issued in the following month. The subdivision will be undertaken in two stages as follows: • Stage 1 - the portion of the Property not being used for the wildlife habitat will be subdivided into a specified number of blocks for sale • Stage 2 - Once the subdivided blocks have been sold, the remaining portion of the Property will be retained as a wildlife habitat. Only the minimum clearing and earth works will be done to meet council requirements. No construction will be undertaken on the subdivided blocks, with the major works consisting of the construction of the new road, landscaping, electricity supply and telephone supply. You and your spouse will engage the services of contractors to undertake all of the activities in relation to the road works, stormwater, clearing of road reserve and telecommunications piping and junction pits. You will also engage the services of surveyors, engineers, and relevant utilities. You and your spouse have engaged the services of the following in relation to the Project: • A town planning consultant, who prepared the development application lodged with the Council • A consulting engineer, who performed all civil engineering design work and liaised with the Council • An electrical contractor to provide electricity supply to the blocks • Surveyors to perform all survey work • An electrical and telecommunications contractor, to provide cabling conduit and pits for the installation of telecommunications cabling; and • Other contractors to perform selective clearing for the road reserve and subdivided blocks. You and your spouse will not borrow any funds in relation to the subdivision of the Property. The estimated market value of the property is between $XXX,000 and $X,XXX,000. The cost to subdivide the Property is estimated to be $XXX,000. You and your spouse will not be physically involved with the subdivision of the Property. You and your spouse will engage the services of a real estate agent/s to sell the subdivided blocks. You and your spouse have not undertaken any similar activities in the past and do not intend any similar activities in the future. For the purpose of this private ruling the following will occur: • You and your spouse will engage the services of professionals to undertake all of the activities in relation to the subdivision of the Property; • The Property will be subdivided in accordance with the Development permit issued by the Council and will be subdivided into two stages as follows: • Stage 1 - the block consisting of the smaller portion of the Property on which the house is located will be subdivided into the specified number blocks for sale • Stage 2 - Once the subdivided blocks have been sold, the remaining larger block will be retained as a wildlife habitat. • You and your spouse will not personally undertake any activities in relation to the subdivision of the Property; and • You and your spouse will engage the services of real estate agent/s to sell the subdivided blocks.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 15-15 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Subsection 104-10(3) | Income Tax Assessment Act 1997 Section 112-25 | Income Tax Assessment Act 1997 Section 995-1 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3 | Income Tax Assessment Act 1997 Division 115

Reasons for decision: Summary: Legislative references referred to herein are from the ITAA 1997 . Summary The proceeds from the sale of the subdivided blocks will not be ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of capital assets which will fall for consideration under the capital gains tax provisions in Part 3-1. Detailed Explanation | Detailed Reasoning - Income or capital: As a general principle, profits from property sales will either be assessable as ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) or statutory income under the capital gains tax (CGT) provisions of the ITAA 1997. Where the profit has been made as a result of a taxpayer carrying on a business of property development or as a result of a taxpayer entering into an isolated business transaction, the profit will be assessable as ordinary income. However, where the profit is a mere realisation of a capital asset, the profit will be assessable under the CGT provisions of the ITAA 1997. The term 'business' ordinarily refers to trade engaged in on a regular or continuous basis. To be engaged in a business of selling property, a taxpayer would need to be buying land and selling property on a regular basis. 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 particular facts. Taxation Ruling 97/11 (TR 97/11) outlines the Commissioner's view on whether a taxpayer is carrying on a business. Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner and the courts consider that the following matters are relevant in determining whether a taxpayer is conducting a business of acquiring property for the purpose of making a profit on its subsequent sale: 1. whether the activity has a significant commercial purpose or character 2. whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity 3. whether there is repetition and regularity of the activity 4. whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business 5. the volume of the operations and the amount of capital employed 6. whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at making a profit, and 7. the size, scale and permanency of the 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 impressions gained from looking at all the indicators and whether these indicators provide the operations with a commercial profile. The Commissioner's view on whether profits from isolated transactions are assessable as ordinary income is found in Taxation Ruling TR 92/3 (TR 92/3). According to paragraph 1 of TR 92/3, the term 'isolated transactions' refers to: • those transactions outside the ordinary course of business of a taxpayer carrying on a business; and • those transactions entered into by non-business taxpayers. Paragraph 6 of TR 92/3 states that profits on an isolated transaction will be ordinary income when: • 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. A transaction that is commercial in nature will be a 'business or commercial transaction'. Broadly, a commercial transaction is one that will constitute carrying on a business except that there are no recurring transactions. Further, an isolated transaction refers to a transaction that is outside the ordinary course of business of a taxpayer carrying on a business and those transactions entered into by non-business taxpayers. In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case. Matters listed in TR 92/3, which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include: • 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. Application to your situation In this case, you and your spouse purchased the Property before 20 September 1985, and it has been used as your main residence. The land area of the Property is more than 2 hectares with a house located on it. The zoning of the Property has changed since it was purchased. The Council will now permit the creation of rural residential allotments in accordance with their specifications which prohibit the subdivision of land into blocks of a smaller or larger land area than the Council will permit. You and your spouse have retired and now want to move closer to your children. You and your spouse want to subdivide the Property with a large portion of it to be used for wildlife habitat usage and the remaining portion of the Property on which the house is located to be subdivided and sold to fund the purchase of a new dwelling near your children. However, as a result of the current zoning applicable to the Property, you and your spouse cannot sell the whole of the portion of the Property with the house located on it as it is too large in accordance with the Council's zoning regulations. Therefore, the Property must be subdivided into smaller blocks. You and your spouse intend subdividing the portion of the Property on which the house is located into a specified number of blocks, which will be sold to fund the purchase of your next home. A Development Application has been lodged with the Council for the subdivision of the Property, which was approved in the month after it was lodged. You and your spouse have engaged the services of others to undertake the activities in relation to the subdivision of the Property. You and your spouse have not previously undertaken any similar activities and have no intention to undertake any similar activities in the future. Based on the information provided, there is nothing to suggest that the subdivision of the Property and the sale of the subdivided blocks will be the beginning of a continuing business of property sales. You and your spouse's activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, it is the Commissioner's view that you and your spouse's activities in relation to the subdivision of the Property and the sale of the subdivided blocks are not those of someone carrying on a business of buying and selling land. Making an overall assessment on the factors set out in TR 93/2, it is the Commissioner's view that the sale of the subdivided blocks will not be considered commercial in nature, given that the Property is a long-held privately owned property. In conclusion, the activities involved in the subdivision of the Property and the sale of the subdivided blocks will not amount to carrying on a business. The transactions will not have the character of business operations or commercial transactions. There is no indication that your activities will become a separate business operation or commercial transaction, or that you will be carrying on, or are carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you are carrying on a business, or that the activities will be an isolated transaction, any profit arising from the sale of the Property, but that it will be a mere realisation of your Property which will be accounted for under the capital gains tax provisions in Part 3-1. | Detailed Reasoning - Capital gains tax: The capital gains tax (CGT) provisions are contained in Part 3-1. Broadly, the provisions include in your assessable income any assessable gain or loss made when a CGT event happens to a CGT asset that you own. CGT event A1 happens if you dispose a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. However, any capital gain or capital loss made on the disposal of a CGT asset will be disregarded if the asset was acquired before 20 September 1985. When a CGT asset (the original asset) is split into two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event, according to subsection 112-25(2) of the ITAA 1997. Where the original land was acquired before 20 September 1985, each new subdivided block retains its pre-CGT status. Application to your situation In this case you and your spouse acquired the original property before 20 September 1985; therefore, the blocks arising from the subdivision of the Property will also be viewed as having been acquired on the date the original property was purchased. That is the block that will be used as a wildlife habitat and each of the subdivided lots arising from the subdivision of the remaining portion of the Property will all retain their pre-CGT status. While CGT event A1 will occur when the subdivided blocks are sold, as the subdivided blocks are viewed as having been acquired before 20 September 1985, being pre-CGT, any capital gain or capital loss you and your spouse make on the disposal of each of the subdivided block will be disregarded for CGT purposes.