Private ruling: CGT event K4
Date of advice: 5 April 2018
Published: June 2018
Ruling period: Year of income ended 30 June 2017
Date scheme commenced: 1 July 2016

Ruling: Q1: Did CGT event K4 happen in relation to the Land on DDMMYY? | A1: Yes | Q2: Is there an amount to be included in the assessable income of Company1 as a result of CGT event K4 happening? | A2: No | Q3: In accordance with paragraph 70-30(1)(a), can Company1 elect that the Land was transferred to trading stock on DDMMYY at its market value at that date? | A3: Yes

Relevant facts and circumstances: Background The Family business enterprises have been conducted over many years. The extended family’s main business activities have included: ● Primary production ● Ownership of long term commercial assets ● Retail trading ● Minority interests in property development activities. The various business operations and assets have passed from one generation to the next, Parent 1 to their children and to the next generation. The businesses were commenced by: ● Parent 1, deceased ● Parent 2, deceased. Their X children became involved in and inherited the family businesses and assets: 1 sibling left the family business taking an appropriate share of the Family enterprise and ceased to hold any interest in them in the early 1990’s. The other 2 siblings conducted the family businesses together for many years, and involved many of their family members in the expectation that they would succeed them and operate the businesses together in the future. In YearD, due to conflicting thoughts around the future of the businesses and in order to achieve an orderly succession to the next generation, the 2 siblings split the family businesses and assets and each took separate parts of the Family enterprise (the YearD separation). Person1 and their family are involved in all aspects of the family businesses that remained under the control of Person1 following the YearD separation. Company1 Company1 was incorporated in early 19XXs for the purpose of purchasing the Land. The directors of Company1 are Person1 and spouse. Current shareholders are all members of Person1’s family or related entities. Activities in relation to the Land The land was purchased by Company1 in the early 19XXs and has been used in Company1’s business, which commenced on the land after its purchase. In YearA, an unsolicited approach was made to Company1 with a proposal to undertake a residential subdivision on the Land. A high level financial modelling and conceptual subdivision plan was prepared at no cost to Company1. This proposal was rejected by Company1. In YearB a lease variation to include ‘residential use’ as another purpose for which the land could be used was lodged with the relevant authority. This lease variation was lodged in order to maximise the value of the Land should it be sold at some point in the future. There was no intention at this point in time to cease running the business on the Land. Late YearC, Company1 became aware of government plans that may increase competition for the Company’s business over the next few years. In early YearD, Company1 became aware that a neighbouring block was available for purchase. Minutes of the Family Meeting early YearD record the decision to purchase the neighbouring block. The neighbouring Block was purchased. It was separated from the Land by a strip of land that contained a storm water pipe and overland water flow swale. Company1 undertook a lengthy negotiation process and finally purchased this intervening strip of land several years later. In YearD, the 2 siblings undertook a separation of the entities that comprised the Family enterprise as it was at that time. As part of this process, valuations were obtained of the entities within the group to ensure an equitable split. Entities were to be valued at their ‘highest and best use’ value. As part of this process, the Land was valued at $X on an ‘as is’ market value. The Valuation report states in the description of the property being valued: An Indicative residential development scheme has been provided for the site which demonstrates the site can accommodate between X-Y units depending on the product mix and staged development of the site. The lease variation to include ‘residential’ use of the Land was granted in YearD. Minutes of a Family Meeting during the 2nd half of YearE record discussion about exploring the possibility of selling the Land. Minutes of a Company1 shareholder’s meeting in the 2nd half of YearE also record extensive discussions around selling the Land. Late in YearE Company2 was incorporated in the event that there was agreement to undertake the development of the Land. Company2 is owned and controlled by the children of Person1, and neither Person1 nor their spouse are a shareholder or director of Company2. Company2 remained dormant until it entered the development agreement at the end of YearH, and only registered for GST after that. Late in YearE, an architect was engaged to provide a concept layout for residential subdivision on the Land. Minutes of the Family Meeting in the 1st half of YearF noted that advice was received on the residential market and the concept layout provided by the architect. The advice recommended a staged release of the Land. The minutes also noted that some siblings had become less comfortable with the risk of developing themselves and favoured selling the land ‘englobo’ with a DA in place. Mid YearF, a valuation was requested based on the concept layout prepared by the architect. Mid YearF, a request for expressions of interest from Architects, Town Planners, Builders, Engineers, and Landscape architects were sought to prepare a residential feasibility study for the Land. These were subsequently withdrawn several months later, as they were considered too premature. Minutes of a Family Meeting during the 2nd half of YearF record various discussions and decisions in relation to exploring the options available regarding selling the Land (sell englobo with DA attached, subdivide and sell serviced land or sell fully developed Land). Late YearF, the development consultant were engaged (under a phased appointment) to undertake the following: ● Phase 1: Investigation of options to design and test development scenarios. ● Phase 2: Upon selection of the preferred option, management of design and approvals, including organising sub-consultants, through to Estate Development Plan (EDP), design development, approvals and implementation. ● Phase 3: Management of construction, marketing and sales. In YearG the development consultant presented a report in 3 parts, and included estimated cost and profits of the 3 options being considered. Mid YearG the development consultant were engaged to undertake the preparation of an EDP to be prepared on the basis of maximising return and to include design controls to ensure the quality of the final product. Mid May YearG staff and clients of the Business were advised that surplus land was to be sold. Mid YearG the following consultants were appointed: ● Town Planners ● Architects ● Landscape Architecture ● Geotechnical Engineering ● Engineers. Minutes of the Family Meeting in the 2nd half of YearG note that it was agreed that it was considered ‘premature to discuss management fees or partnership agreements with the development consultant until the family had decided whether they wish to be involved in a development’. In the 2nd half of YearG, the development consultant provided an updated commercial feasibility analysis of the various options being considered for the Land. Late in YearG, informal discussions were held with the Bank regarding financing options for the various development options, however no formal applications for funding were made as no decision as to the actual type of development (and therefore funding requirements) had been made. Minutes of the Family Meeting of late YearG record that no decision had been made, but that the preferred option was either the development of serviced land or englobo sale with DA in place. In early YearH, there were record land sales in a nearby newly developed suburb, which led to consideration of whether developing the Land would result in the desired profit as opposed to selling the Land with DA attached, or selling serviced Land. An updated feasibility report from the development consultant in early YearH showed lower than desired profit on house and land development considering the risk involved. Minutes of the Family Meeting during the 1st half of YearH record that the preferred options are either selling with DA in place or developing and selling serviced land but not to consider undertaking building work. The Development Agreement for the Land was lodged mid YearH. Minutes of the Family Meeting in the 2nd half of YearH record that agreement was reached to accept the limited development risk and proceed with the option to develop and sell serviced land. The decision was also made to split the development into 3 stages, with sales of stage 1 to commence at the earliest opportunity. Late YearH, a Development Agreement was entered into between Company1 and Company2. A sales agreement was entered into after an updated valuation was provided. As at late YearH, the Land was valued at $Y. The business that had been conducted by Company1 on the Land since it was purchased was transferred to a related entity early YearJ, allowing the business to continue in a separate entity. Stage 1 Land has been auctioned. Total sales were approximately $Z. Sales were all subject to the DA being approved. The subdivision was approved mid YearJ, subject to certain conditions. Given the success of the initial land sales, and further small release of additional land, the decision was made to proceed with a one-stage development, rather than a staggered 3-stage approach. The only business activity currently being carried on by Company1 was the subdivision development and sale of the Land. By mid YearJ, staff were notified that the whole of the Land would be developed at once, not in stages as originally intended.

Relevant legislative provisions: Income Tax Assessment Act 1997 section 70-30 | Income Tax Assessment Act 1997 paragraph 70-30(1)(a) | Income Tax Assessment Act 1997 subsection 70-30(2) | Income Tax Assessment Act 1997 subsection 104-220(2) | Income Tax Assessment Act 1997 subsection 104-220(4)

Reasons for decision: Summary: CGT event K4 happened in relation to the land on DDMM YearH. Any capital gain or loss will be disregarded as the asset was acquired prior to 19 September 1985. In accordance with paragraph 70-30(1)(a), Company1 can elect that the Land was transferred to trading stock on DDMM YearH at its market value at that date. | Detailed Reasoning - Detailed reasoning: CGT event K4 happens when you start holding as trading stock a CGT asset that you already own and you elect to be treated as having sold the asset for its market value under paragraph 70-30(1)(a). The time of CGT event K4 is the time that you started holding the CGT asset as trading stock. (subsection 104-220(2)) A capital gain or capital loss that you make is disregarded if you acquired the asset before 20 September 1985. Taxation Determination TD 92/124 Income tax: property development: in what circumstances is land treated as ‘trading stock’? provides that land will be treated as trading stock if it is held for the purpose of resale and a business activity which involves the dealing in land has commenced. Both the required purpose and the business activity must be present. The business activity will be taken to have commenced once there is a definite and continuous cycle of operations designed to lead to the sale of the land. In considering whether either a business has commenced or activities are merely preliminary to commencement of the business, the element of commitment is important ( Softwood Pulp and Paper Limited v Federal Commissioner of Taxation 76 ATC 4439, Goodman Fielder Wattie Ltd v Federal Commissioner of Taxation (1991) 101 ALR 329. In Whitfords Beach Pty Ltd v Federal Commissioner of Taxation 83 ATC 4277 , the full Federal Court had to consider at what point in time land was ventured into a business of developing, subdividing, and selling land at Whitfords Beach. Bowen CJ, Morling and Fitzgerald JJ considered that this occurred when there was both a ’persistent intention to develop, subdivide and sell all of the... land and a continuous course of conduct directed to the implementation of that intention ’. Company1 purchased the Land in the early 19XXs and it is accepted that it was not trading stock at the time it was purchased. Rather it was a capital asset of Company1 and used in its business. The business is still being run within the family group, but is no longer being run by Company1, having been transferred to a related entity (Company2) in YearJ. Company1 is now in the business of subdividing and selling the Land as serviced lots and the Land is now trading stock of this new property development business. CGT event K4 happened at the time that the nature of the Land changed from being a capital asset of the business to trading stock of the development business. At issue is the timing of when this occurred. This cannot be a date earlier than when the business of property development commenced. If the Land were to be sold englobo with a Development Agreement attached, it is agreed that this would be a mere realisation of a capital asset. The Land has been held by Company1 for over 50 years, and since purchase the land has been used in its business. There is no evidence available that would suggest that, at the time of purchase, there was any intention to subdivide and develop the property. The sale of the Land without any development activity being undertaken on the Land prior to sale would not be sufficient for a finding that a business of subdividing/property development was being undertaken (Taxation ruling TR 92/3 Income tax: whether profits on isolated transactions are income; Taxation ruling TR 2017/D7 Income tax: when does a company carry on a business within the meaning of section 23AA of the Income Tax Rates Act 1986?) . As a result, if the Land is sold englobo, the sale will be on capital account and any capital gain made from the sale will be disregarded as the Land was purchased prior to 20 September 1985. Therefore, the Land will only become trading stock of a business of property development on or after the date that there was a firm commitment to undertake the property development, as opposed to merely selling the Land englobo with a DA attached. | Detailed Reasoning - Potential business commencement dates: YearA In YearA an unsolicited approach was made to Company1 with a proposal for a residential subdivision on the Land. This proposal was dismissed, and the Land continued being used in the business. There is no evidence that the purpose for holding the Land had changed from one of use in the business to one of trading stock in a property development business at this time. This unsolicited approach may have sown the seed in the minds of the directors of the potential for subdivision of the Land at some point in the future, but that is not sufficient to support a finding that a business of dealing in land had commenced or that the Land had been transferred to trading stock at this time. YearB A lease variation on the Land was requested to include residential use in the purpose clause. The family have advised that this was done to improve the valuation of the Land, in conjunction with the YearD restructure of the Family enterprise. The business continued to be undertaken on the Land. The lease variation does facilitate the future subdivision of the land into residential lots, however, without anything further, this is insufficient to conclude that a business of property development had commenced at this point. Therefore CGT event K4 did not happen at this time. YearE Key events that occurred around YearE are: ● the neighbouring property was purchased (by an associated entity), to prevent a competitor to the business establishing on their door step. ● the family business enterprises were restructured and split between the two siblings. ● family meeting held where the possibility of moving the business to the neighbouring block and selling off the Land was discussed and it was agreed to investigate this possibility. Advice was provided on the taxation consequences of the three options being considered: selling englobo with a DA attached, subdivide and sell, or subdivide and sell house and land packages. ● Company1 shareholder’s meeting agreed to undertake a feasibility study into future development of the Land. ● a new entity, Company2, was established to undertake the feasibility work and the development if it was decided to proceed. All these activities show that by YearE, the sale of the Land was in serious contemplation. However, there is no evidence that a decision had been made to definitively commit the Land to a business of property development. Steps had certainly been put in place to explore the possibilities, including undertaking a feasibility study into the various options. However, merely undertaking feasibility studies is insufficient to conclude that a business of property development had actually commenced ( Softwood Pulp and Paper Limited v Federal Commissioner of Taxation 76 ATC 4439, Goodman Fielder Wattie Ltd v Federal Commissioner of Taxation (1991) 101 ALR 329). YearF Key events that occurred during YearF ● Engineering consultants and architects were paid for preliminary work in relation to the potential subdivision and sale of the Land. ● Expressions of interest were sought from specific architects, town planners, builders, engineers, landscape architects. These were subsequently withdrawn 1 month later due to indecision as to the best approach to be taken. Therefore, by YearF, the potential sale of the Land continued to be in serious contemplation, and, although it may not have been stated outright, a decision probably had been formed to actually sell the Land. However, there is no evidence to support a finding that by this time, the decision had been made to proceed with the subdivision option as opposed to merely realising the asset by way of englobo sale of Land with DA attached. The fact that expressions of interest were issued and then withdrawn 1 month later supports a finding that there had been no decision made at that time to proceed with the development. YearG - YearH Key events that occurred during YearG and YearH: ● The development consultants were engaged to provide feasibility modelling on the various options available. ● Various additional professional services are engaged to provide input into the feasibility and planning process. ● Expenses were incurred for the feasibility modelling/concept designs provided, and other professional services. These expenses were paid out of Company1 funds, no external finance was obtained. ● An initial, informal discussion regarding potential funding for the development should it proceed was held with the Bank late in YearG. ● EDP application was lodged mid YearH. ● Minutes of the family meeting on DDMM YearH record the decision being made to proceed with the development, rather than merely selling the Land englobo with attached DA. During this period, a not insignificant amount was spent by Company1 on the feasibility studies etc in relation to the sale of the Land. However, this should be compared to the total cost of the subdivision, (either to develop and sell subdivided land, or to develop and sell house and land packages). Additionally, this amount was paid out of existing Company1 funds – no external finance was obtained. Therefore, this factor alone is insufficient evidence to find that a business had commenced in YearG on engagement of the development consultant. During this period (YearG and YearH years) the options of undertaking the development are clearly in serious contemplation, and it could probably be said that it was more likely than not that the development would proceed (as opposed to merely selling the Land englobo with DA attached). The family meeting held on DDMM YearH is the first recorded evidence that a decision had been made to definitively commit to the subdivision and development. Up until this date, there was always the option to sell engloblo, especially considering Person1’s evident aversion to undertaking the development. It is considered that it is DDMM YearH when the element of commitment and a continuous course of conduct commenced specifically directed towards the business of subdivision and sale of the Land rather than merely realising the Land via an englobo sale with DA attached. Accordingly, CGT event K4 happened in MM YearH when the decision was made to proceed with the subdivision, rather than merely realising the Land by way of an englobo sale with DA attached. Because the Land was acquired before 20 September 1985, it was a pre-CGT asset, and therefore any capital gain or loss made from CGT event K4 happening is disregarded (subsection 104-220(4)). | Detailed Reasoning - Trading stock: Under section 70-30, if an item you own later becomes part of your trading stock you are treated as if you had sold that item to someone else (at arm’s length) and immediately bought it back for the same amount. Under paragraph 70-30(1)(a) you can either elect that this amount be either the cost of the item (as calculated under subsections (3) or (4)), or its market value just before it became trading stock. Therefore, Company1 can elect under paragraph 70-30(1)(a) to treat the Land as having been acquired at market value on DDMM YearH. Under subsection 70-30(2) Company1 must make this election by the time that it lodges its income tax return for the income year ended 30 June 2017.