Private ruling: Subdivision
Date of advice: 22 November 2018
Published: February 2019
Ruling period: Year ended 30 June 20XX | Year ended 30 June 20XX | Year ended 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will the subdivision and sale of the subdivided lots of land constitute an isolated profit making transaction (not a mere realisation) where the sale proceeds are treated as assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: You are the legal and beneficial owner of a property. You acquired the property pursuant to the Will of your parents and you have lived in the property. The property has risen significantly in value over the years and now represents a substantial portion of your net assets that will ultimately provide a source of retirement funding once sold. There is an easement that runs through/joins the property that is currently owned by and dedicated to the council. You intend to acquire this easement so as to improve the saleability and realisable value of the property. The council does not require the easement to be purchased for the subdivision to proceed. You have been approached by an independent property developer whereby they had advised you that you would derive a better economic result by allowing them to develop the land as opposed to selling as is. After consideration of the proposal and discussions with real estate agents, you entered into a property development agreement with the developer. The agreement incorporates a loan and an option agreement containing the entire understanding and agreement between you and the developer in relation to the subdivision project. Under the agreement the parties agree that the property will be subdivided into a number of residential lots. The developer will undertake all the necessary subdivision and ancillary work on your behalf and will pay all project costs based on the terms of the agreement. The developer will update you of all information in relation to the subdivision project. You will purchase the adjoining land from the council and the developer will lend you funds to finance the purchase subject to the terms and conditions of the loan agreement. You will be responsible for all of the compliance requirements issued by any competent authority in relation to the subdivision project. Under the option agreement you will transfer one lot to the developer in consideration for completing the subdivision project.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5

Reasons for decision: Summary: Whether the subdivision and ultimate sale of the subdivided land is a ‘mere realisation’ or something more like an isolated profit making transaction will depend on the facts and circumstances of each case. A ‘mere realisation’ is a sale on capital account. Whereas a sale that is more than a ‘mere realisation’ like an isolated profit making transaction will be on revenue account and proceeds from the sale will generally be assessable income under section 6-5 of the ITAA 1997. Taxation Ruling TR 92/3 provides guidance in determining whether profits from isolated profit-making transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 (at paragraph 35) provides that if a taxpayer makes a profit from a transaction or operation, that profit is income even if the transaction or operation is not in the course of the taxpayers business but: ● the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and ● the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits from the transaction can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 (at paragraph 13) lists the following factors to be considered: a) the nature of the entity undertaking the operation or transaction b) the nature and scale of other activities undertaken by the taxpayer c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained d) the nature, scale and complexity of the operation or transaction e) the manner in which the operation or transaction was entered into or carried out f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction g) if the transaction involves the acquisition and disposal of property, the nature of that property, and h) the timing of the transaction or the various steps in the transaction. Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: ● there is a change of purpose for which the land is held; ● additional land is acquired to be added to the original parcel of land; ● the parcel of land is brought into account as a business asset; ● there is a coherent plan for the subdivision of the land; ● there is a business organisation – for example a manager, office and letterhead; ● borrowed funds financed the acquisition or subdivision; ● interest on money borrowed to defray subdivisional costs was claimed as a business expense; ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and ● buildings have been erected on the land. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Application to your circumstances: ● There is a change of purpose for which the land is held because you have decided to venture the property into a profit-making project by engaging a property developer to subdivide the land. You have given consideration of the project proposal and you have had discussions with real estate agents before making up your mind on the subdivision of the property. ● There appears to be a substantial long term purpose of profitable development and sale of the subdivided land considering you hold the property for a longer time prior to embarking on the subdivision project. ● You will be acquiring additional land for the easement in order to improve the saleability and realisable value of the property following subdivision. ● You have borrowed funds to finance the acquisition of the additional land for the easement and under the terms of the loan agreement default interest will accrue if you fail to pay the sum payable; ● There is a coherent plan for the subdivision as you have entered into an agreement with the property developer. ● By entering into a development arrangement it demonstrates that you have made a choice to expose yourself to the financial risks of the development and its general success. ● Although the developer will pay all the project costs and indemnify you in relation to all project costs as defined in the agreement, you are still exposed to other costs such as your loan repayments, council rates, water rates, legal and accounting fees, and any tax liability in relation to the land. ● Despite the developer will manage the subdivision project on your behalf there’s a level of sophistication and complexity in the arrangement, for example, you entered into an option agreement and a loan agreement incorporating the terms of the development agreement. ● You are responsible for all of the compliance requirements issued by any competent authority in relation to the subdivision project and that you are updated by the developer with all information in relation to the project. As such you are in fact involved in the development activities despite you engaged a developer or project manager. Therefore by weighing all the facts and circumstances of your case and on balance of all probabilities, it is considered the subdivision and sale of the subdivided lots of land which you own constitute an isolated profit-making transaction (not a mere realisation). As such the sale will be on revenue account and proceeds from the sale are treated as assessable income under section 6-5 of the ITAA 1997.