Private ruling: Property - subdivision - disposal - income v capital
Date of advice: 14 July 2016
Published: August 2016
Ruling period: 1 July 2015 to 30 June 2016 | 1 July 2016 to 30 June 2017 | 1 July 2017 to 30 June 2018 | 1 July 2018 to 30 June 2019 | 1 July 2019 to 30 June 2020
Date scheme commenced: 1 July 2015

Ruling: Q1: Will the profit from the sale of the subdivided lots 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 lots 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 lots 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: Documentation and information has been provided with this private ruling, and the previous private ruling, which should be read in conjunction with and forms part of this scheme. You and your spouse signed the contract to jointly purchase the vacant block of land after 20 September 1985 (the Property). The land area of the Property is greater than two hectares. Settlement on the purchase of the Property occurred during the following income year after the sale contract had been entered into. You and your spouse purchased the Property for the purpose of building your main residence in the future. You and your spouse incurred expenses in relation to construction of a dwelling on the Property during the income years after the Property was purchased. You and your spouse sold your main residence to help fund the construction costs of the new dwelling on the Property. Around ten years after the Property was purchased, you and your spouse's circumstances changed due to medical issues. As a result, you and your spouse relocated to another area away from the Property. The construction of the dwelling on the Property was put on hold, with construction to recommence in the future. You and your spouse purchased a new house located at your new location a number of months after you had moved to the new location. This dwelling is your main residence. A number of years after you and your spouse had moved to the new location a Government Minister issued a media release in relation to a planning scheme (the Scheme) for the area in which the Property is located. The Scheme was finalised during the following income year. You and your spouse determined that the Property was too large for you to look after given the medical issues, and as a result you and your spouse only wanted to keep a smaller property. As a result of the issuing of the Scheme, you and your spouse commissioned a feasibility investigation (the Report) into the Property to assess the opportunity to utilise the unused land on the Property. The Report outlined the following: • The Property presented an excellent opportunity for residential subdivision with it being in close proximity to the coastline, which would allow for the creation of several waterfront allotments, which would be considered of a premium quality • An internal road is proposed to run through the centre of the Property, and road works will be undertaken to extend existing streets. Some of the servicing works are required. A number of the proposed allotments would have water frontages • A concept plan was prepared which identified that the subdivision of the Property will be undertaken a number of stages; and • It was determined that the waterfront lots proposed in the subdivision were anticipated to sell for premium price, at a price higher than expected for the non-waterfront lots. As a result of the feasibility investigation, you and your spouse have decided to maximise the value of the Property and that it should be subdivided into multiple lots. A Development Permit was prepared which outlined that the Property would be subdivided into a specified number of lots, and that the subdivision would be undertaken over a specified number of stages. Approval of the Development Permit was granted by the local Council in the year following the release of the Scheme. Valuations of the Property have been obtained which indicate that the current market value of the Property is over $700,000. You and your spouse will spend over $1,000,000 on development costs in relation to the subdivision. You and your spouse will borrow the money to fund the subdivision activities. It is estimated that you and your spouse will sell the subdivided lots for over $2,000,000 It is intended that the development and sale of the subdivided lots will be conducted in a specified number of stages over a number of years to reduce the need for borrowings, and to avoid flooding the market with available property. You and your spouse will sell the subdivided lots along the existing road, and use the proceeds of the sale to fund the next stage of the development. You and your spouse will retain ownership of one of the subdivided waterfront lots for the purpose of building a dwelling that will become your main residence. You and your spouse will engage the services of other parties to undertake the activities arising in relation to the subdivision of the Property. You and your spouse will engage the services of real estate agent/s to sell the subdivided lots. You and your spouse have not undertaken any similar activities in the past and will not undertake any similar activities in the future. For the purposes of this ruling the following will occur: • You and your spouse will engage the services of others to undertake the activities arising in relation to the subdivision of the property • You and your spouse will engage the services of real estate agent/s to sell the subdivided lots • You and your spouse will sell all of the subdivided lots, with the exception of one which you and your spouse will keep to build your main residence • You and your spouse will not undertake any activities in relation to the subdivision and sale of the subdivided lots • The subdivision of the Property will be undertaken in accordance with the Development Permit provided with this ruling and will: • Undertake the subdivision and sale of the subdivided lots in the specified number of stages • Subdivide the Property into the specified number of lots; and • You and your spouse will incur expenses in relation to the subdivision, such as road works, stormwater drainage and connection of water, electricity and telephone; and • No construction will occur on the subdivided lots prior to them being sold.

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 lots 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 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, with settlement occurring after 20 September 1985. You and your spouse commenced activities in relation to the construction of a dwelling on the Property; however the dwelling was not constructed due to health issues. The local planning rules changed in relation to the area the Property is located a number of years after the Property was purchased. As a result of the change to planning rules, you and your spouse commissioned a feasibility investigation to assess the subdivision of the Property. You and your spouse have made the decision to subdivide the Property for the purpose of selling the majority of the subdivided lots. You and your spouse will keep one of the subdivided lots on which you will build a dwelling with the intention that it will be your main residence. You will engage the services of others to undertake the activities in relation to the subdivision of the Property and the sale of the subdivided lots. 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 lots 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 lots 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 lots 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 lots 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, 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 of a CGT asset. A CGT asset is any kind of property or a legal or equitable right that is not property. You will make a capital gain if the capital proceeds received for the asset are more than the asset's cost base. You will make a capital loss if the capital proceeds received for the asset are less than the asset's cost base. Application to your situation A CGT event A1 will occur when the subdivided lots are sold. As the gain made on the sale of the Property will not be assessable as ordinary income under section 6-5, it will be assessable under the CGT provisions. Therefore, any capital gain or capital loss made on the disposal of your ownership interest in the subdivided lots will be calculated under the CGT provisions. Note: If you and your spouse meet the conditions contained in Division 115, the 50% CGT discount can be applied to any gain made on the disposal of the subdivided lots.