Private ruling: Proposed property development
Date of advice: 25 August 2017
Published: December 2017
Ruling period: 1 July 201B to 30 June 202C
Date scheme commenced: 201A

Ruling: Q1: Will the profit on the proposed sale of the subdivided lots constitute assessable income under section 6-5 of the Income Tax Assessment Act (ITAA 1997)? | A1: No

Relevant facts and circumstances: 1. An entity operated a store within premises owned by a factory for 100 years. This location held considerable goodwill. The factory required the business to relocate, additionally, the store had outgrown the existing premises and was seeking to grow and expand. There was a need to relocate due to site and building constraints which limited the company’s operations and business development potential. For these reasons land was sought as close as possible to the stores previous location for the construction of a warehouse and storage yard. Land was purchased by the business close to its previous business location. No suitable land of a smaller size was available within close proximity to the factory to accommodate the building of an industrial shed. It was apparent that land swapping would be necessary to achieve an industrial zone to enable the industrial shed to be built. Following the land swaps the industrial shed was built. 2. A contract for sale was signed subject to the purchaser obtaining planning approval or written consent from a Council for the construction and use of an industrial shed. 3. Only a small portion of the block of land was required for the business. 4. The land on acquisition was zoned as farming land and entity took the risk that planning approval would be obtained enabling it to operate as a business. During the application for rezoning from farming to industrial land it was apparent that land swaps would be necessary to achieve a continuous industrial zone in order to build a shed. 5. A subdivision agreement was signed between various parties and the land swaps occurred on a commercial arm’s length basis. 6. The entity plans to subdivide the residual land into a small number blocks and sell them sporadically over several years due to low levels of demand. 7. An engineer and surveyor will be appointed to manage the project after planning approval. 8. A real estate agent will be appointed to manage the marketing and sale of the blocks. 9. The owners will not have an active role in the development or sale of the subdivided property. 10. The project will involve civil works, roads, plumbing, service connections etc for the proposed blocks. 11. There are no loan agreements in place. 21. The entity does not have any other property investments or been involved in any other property development activity. 23. Without rezoning the shed for the business could not have been constructed and the business activities of that entity could not have been conducted on that site. Assumptions None

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 70-10 | Income Tax Assessment Act 1997 Subsection 70-30(1)

Reasons for decision: Summary: While there is a commercial quality to the transactions whereby new industrial property lots will be produced from the surplus landholding, the form and extent of the commercial activities undertaken by the entity are not sufficient to change the character from capital to revenue. Therefore the revenue from the sale of proposed industrial lots would merely be the realisation of a capital asset. | Detailed Reasoning - Detailed reasoning: Generally, the proceeds of the sale of land will be taxed in one of three ways: (1) As ordinary income, where the land is held as trading stock and sold as part of a business. (2) As ordinary income, where the land is not trading stock and is sold as part of an isolated profit making scheme or undertaking; or (3) On capital account, where the proceeds of sale are a mere realisation of a capital asset. Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) assesses income derived according to ordinary concepts, which is called ordinary income. The ordinary income of a business operation or commercial transaction includes amounts derived from certain isolated transactions entered into with the purpose of making a profit: FC of T v The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693 (‘ Myer ’). The proceeds from the sale constitute ordinary income under section 6-5 of the ITAA 1997 where the entity is carrying on a business of property development. Trading stock Subsection 70-10(1) of the ITAA 1997 provides that trading stock includes: (a) anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business; and (b) livestock The High Court has accepted that land can be trading stock (see Federal Commissioner of Taxation v St Hubert’s Island Pty Ltd (1978) 138 CLR 210 which considered the meaning of “trading stock” in the Income Tax Assessment Act 1936 ). The Commissioner’s view on when land is trading stock is provided in Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as ‘trading stock’ , which provides: 1. Land is treated as trading stock for income tax purposes if: ● it is held for the purpose of resale; and ● a business activity which involves dealing in land has commenced. 2. Both the required purpose and the business activity must be present before land is treated as trading stock… Held for the purpose of sale In R & D Holdings Pty Ltd v Deputy Federal Commissioner of Taxation 2006 ATC 4472 Finn J, after identifying the St Hubert’s Island case as the seminal case on whether land can be trading stock, made the following comments about the decision in St Hubert’s Island (at 4480): 46. The significance of this case for present purposes is that it is authority for the propositions that (i) land acquired for the purpose of development, subdivision (or strata division) and sale by allotments (or lots) can constitute trading stock of a business having that purpose irrespective of whether the land has been so developed and subdivided; and (ii) that business will be carried on for so long as the taxpayer engaged in the effectuation of the purpose of development, etc of the land. The emphasis in St Hubert’s Island on the need to have the relevant intention of sale at the time of acquisition of the property in question is, though without significance for s 70-10 purposes which as I have earlier noted links the intention or purpose of sale with the purpose (or purposes) for which the property is held. (emphasis in the original) Finn J went on to discuss the High Court decision in John v Federal Commissioner of Taxation (1989) 166 CLR 417, which also considered the meaning of “trading stock” in the 1936 Act, and made the following comments about purpose (at 4481): 50. …, there is one aspect of John which is of present assistance. It was indicated in the joint judgement (at 430) that the s 6(1) definition of “trading stock was predicated on the prescribed purpose (i.e. of manufacture, sale or exchange) attending the acquisition of the item in question”. However, it was indicated that the definition did not require that the relevant purpose be the sole or dominant purpose”. I can see no reason why a like view should not be taken to the like purpose requirement for which the relevant property is held in the s 70-10 definition of the 1997 Act. The significance of this for present purposes is that I have found below that R & D Holdings held the Bulletin Place property at the relevant time for the dual purposes of sale or lease of subdivided lots. These two purposes clearly are not “contrary or inconsistent”… The subject land is not trading stock because the residual land was not held with the intention of resale for profit. It was held for the purpose of building an industrial shed and as the surplus land is not required for the business a subdivision is proposed to realise the land in the most advantageous way. | Detailed Reasoning - Carrying on a business: Taxation Ruling TR 97/11 sets out the Commissioner’s view on when an entity is carrying on a business. The ruling specifically considers whether an entity is carrying on a business of primary production, but the indicators of business identified also apply to other areas: 26. From the judgments it is clear that the relevant indicators of whether a business of primary production is being carried on by a taxpayer are: ● does the activity have a significant commercial purpose or character? ● does the taxpayer have more than a mere intention to engage in business? ● is there an intention to make a profit or a genuine belief that a profit will be made? Will the activity be profitable? ● is there repetition and regularity in the activity? i.e., how often is the activity engaged in? How much time does the taxpayer spend on the activity? ● is the activity of the same kind and carried on in a similar way to that of the ordinary trade? ● is the activity organised in a businesslike manner? ● what is the size or scale of the activity? ● is the activity better described as a hobby, a form of recreation or a sporting activity? In Westfield Ltd v Federal Commissioner of Taxation 21 ATR 1398 Hill J made the following comments about the purpose of sale of property in carrying on a business, in the context of determining whether profit from the sale of land was income under former sections 25 and 26 of the 1936 Act: … It does not, however, follow …, that every profit made by a taxpayer in the course of his business activity will be of an income nature. To so express the proposition is to express it too widely, and to eliminate the distinction between an income and a capital profit. A taxpayer carrying on a business might sell its headquarters in order to move to larger premises and make a profit over historical cost. The transaction of sale may be one which arises in the ordinary course of the taxpayers business, but that profit will not ordinarily be income, particularly where, at the time of acquisition of the site, there was no intention or purpose of profit-making by sale when the premises became too small… The Property Trust is not carrying on the business of property development and neither the Trust nor any of its related entities have been involved in property development in the past. The land was purchased with the intention of building an industrial shed. It was not purchased with the intention of profit making by developing and/or selling the land. Having regard to the indicators discussed in TR 97/11, it is not considered that the Property Trust is carrying on a business of property subdivision, development and sale. | Detailed Reasoning - Isolated transaction: Taxation Ruling 92/3 whether profits on isolated transactions are income states that any profit from an isolated transaction is generally income when both of the following elements are present: ● The intention or purpose of the 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 or business operation or commercial transaction. | Detailed Reasoning - First element: profit making intention: The relevant intention or purpose of the taxpayer in determining whether the profit from an isolated transaction is income is the objective purposes of the taxpayer, that is, the taxpayer’s intention or purpose in undertaking the transactions is determined from an objective consideration of the facts and circumstances of the case: TR 92/3, paragraph 7; Myer 163 CLR 199, 209-210; 87 ATC 4363, 4366-4367; 18 ATR 693, 697. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction that gives rise to the profit. It is sufficient if profit-making is a significant purpose: TR 92/3, paragraph 40; FC of T v. Cooling 90 ATC 4472, 4484; 21 ATR 13, 26. If the transaction under review involves the sale of property, it is usually necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property, however that is not always the case: TR 92/3, paragraph 41; see also White v. FC of T (1968) 120 CLR 191; 15 ATD 173. The decisions in Casimaty v. Federal Commissioner of Taxation (1997) 97 ATC 5135; 37 ATR 358 ( Casimaty ) and McCorkell v Federal Commissioner of Taxation 98 ATC 2199; (1998) 39 ATR 1112 ( McCorkell ) demonstrate that if a taxpayer does not intend to make a profit when he or she acquires farming land then the likelihood that any profit made on the eventual sale of land being considered ordinary income is greatly diminished. Paragraphs 56 and 57 of TR 92/3 sets out what objective intentions the ATO considers will give rise to a profit made from an isolated transaction being assessable as income according to ordinary concepts. The requisite intentions are: ● Where a taxpayer acquires property with a purpose of making a profit by which ever means prove most suitable and a profit is later obtained by any means which implements the initial profit-making purposes, ● Where a taxpayer acquires property contemplating a number of different methods of making a profit and uses one of those methods in making a profit, and ● Where a taxpayer enters into a transaction or operation with a purpose of making a profit by one particular means but actually obtains the profit by a different means. The Commissioner therefore considers that the sale of property will be a profit making scheme if the taxpayer had a profit making intent at the time the land was acquired and it need not be established that the profit arose in the manner initially intended or contemplated. Based on the facts provided above, a profit making intention was not a significant factor in the decision making process to obtain the land. The main driver was the need for a suitable site to build a shed for the business. | Detailed Reasoning - Second element: Business operation or commercial transaction: Paragraph 46 of TR 92/3 states that: if a taxpayer enters into a transaction in the course of carrying on a business, it is not necessary to consider whether it is a business operation or commercial transaction. However, it is necessary to consider this issue if the taxpayer is not carrying on a business or if the transaction or operation is not in the course of the taxpayer’s business. Paragraph 47 of TR 92/3 goes on to state that, for a transaction to be characterised as a business operation or commercial transaction, it is sufficient if the transaction is business or commercial in character … Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case’. Paragraph 49 of TR 92/3 provides a list of factors which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction. These factors 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. In FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; (1982) 82 ATC 4031; [1982] HCA 8 (‘ Whitfords Beach ’) land previously held as a capital asset was subdivided and sold. The High Court held that the taxpayer’s actions amounted to more than a mere realisation of a capital asset and as such constituted the carrying on of a business of land development. In the case Mason J noted, ‘[w]here the planned subdivision takes place on a massive scale, involving the laying-out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realization of an asset.’ By contrast, in McCorkell the court found that the proceeds of sale by the applicant of subdivided land he previously used in his orchard activities did not constitute assessable income. It was held that the adoption of a relatively passive role rendered the land development and sale of the allotments as the realisation of a capital asset. The taxpayer had entered into two contractual arrangements; the first involved a surveyor and engineer who subcontracted the work on the subdivision; and the second involved joint estate agents who recommended sale prices and dealt with all potential purchasers. The taxpayer did not contract or deal with the contractors or purchasers and had minimal involvement with advertising. The ATO view is that the profit from isolated transactions may be considered income where the entity is carrying out a business operation or commercial transaction. Therefore, based on the factors listed in paragraph 49 of TR 92/3, it is considered the proposed sale of land, will not be a business operation or commercial transaction. The various steps in the transaction point to the primary motive of the Property Trust being to obtain land to build a shed rather than carrying on a business of property development or profit from an isolated commercial transaction. | Detailed Reasoning - Mere Realisation: A ‘mere realisation’ is a sale on capital account to which the CGT rules will generally apply. Whether a sale is a mere realisation or something more will be determined by weighing all the facts and circumstances taken as a whole. The courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. The expression “mere realisation” is used to contradistinguish a business operation or commercial transaction carrying out a profit-making scheme (TR 92/3, paragraph 36). Mason J observed in Whitfords Beach Pty Ltd v FC of T 79 ATC 4047, that where activities undertaken compromised “development and improvement of land to such a marked degree that it is impossible to say that it is a mere realisation of an asset”. Further, Deane J noted in the same case that the amount of subdivisional work undertaken, rather than scale alone, will cause land to be held on revenue account. This was supported by the Full Federal Court in Stratham v FC of T 89 ATC 4070, where it was held that: “the mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation of those activities is a relevant matter to be taken into account in determining the nature of the realisation”. Here, the facts contrast with Whitfords Beach where it was found by Mason J that: “ However, apart altogether from this factor, the facts previously mentioned show that there was involved more than mere realization of an asset. Deane J. was right in pointing to the circumstance that the asset was divided and improved in the course of a business of dividing and improving the asset. In this respect I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realization of an asset merely because it is an enterprising way of realizing the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realization of an asset. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case”. Weighing all of the evidence together, on balance it is more likely than not that the sale of the Land constitutes a mere realisation of a CGT asset (even though that realisation occurred in an enterprising way), and any profit made is assessable on capital account. Consequently, the profit you made is capital in nature and subject to Part 3-1 of the ITAA 1997. It is not considered ordinary income assessable under section 6-5 of the ITAA 1997. | Detailed Reasoning - Conclusion: Considering all the factors in Taxation Ruling 92/3 and relevant case law the intention of the controlling mind on purchasing the land was not profit making from property development, rather it was to build a shed to enable it to continue to carry on its business and to realise the surplus land in the most advantageous way. Therefore, any proceeds from the sale of the subdivided industrial lots will be on capital account.