Private ruling: Property - subdivision - Am I in business? - isolated transaction - mere realisation
Date of advice: 1 September 2016
Published: October 2016
Ruling period: Income year ending 30 June 2016 | Income year ending 30 June 2017 | Income year ending 30 June 2018; and | Income year ending 30 June 2019.
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: Your parents purchased a property (the Property) before 20 September 1985, as an active and on-going farm. The land area of the Property is around XXX acres. Due to the increase in their farming activity over the following years, your parents needed to expand their acreage and purchased additional land, which was adjacent to the Property, before 20 September 1985. The Land is under two titles, with both titles for land areas of around XX acres. The Property and the Land were zoned as farming land. Over the following years, your parents utilised the Land in relation to their farming activities. Parent A passed away after 20 September 1985, and both properties passed to your surviving parent (Parent B) in accordance with Parent A's will The Property was sold by Parent B shortly after Parent A passed away, and Parent B retired. Prior to 2010, the local Council (the Council) rezoned the properties to Residential 2 which enabled the properties to be sold and developed as one acre lots. Parent B retained the Land and continued the farming activity on the property until they passed away over 40 years after the Land had been acquired. In accordance with Parent B's will, the Land was left to you and your sibling (Person A), in equal shares. Since Parent B passed away until the present time the Land has continued to be used for the same farming activity. The title of the Land was transferred into you and Person A's names in the year after Parent B passed away. The Land has high density residential developments on a number of its boundaries, with low density housing development and recreational areas located near the Land. The Council released a Plan (the Plan) for the Shire forecasting that over the next 30 years the population of the Shire, and in particular area in which the Land is located, would double. The Plan outlined the following in relation to the Land: • Due to its location within the area growth boundary, the Land was identified to be rezoned as General Residential 1 • The Land is located within the distance range for the facilitation of high density residential development within 700 metres of the local town centre • The Land has significant infrastructure, access and services currently available with residential developments currently located on some of the property's boundaries • The Land has no known environmental risks that would prohibit or impact high density residential development and its location is adjacent to the town's major sporting precinct; and • The Land was identified by the Plan as being in an area with the most potential for future residential growth with the property having the benefits of existing infrastructure, services and close access to the town centre and rail network. Following the release of the Plan, the Council encouraged you to provide a proposal declaring your interest in having the Land rezoned to General Residential 1. Over three years after Parent B passed away a rezoning proposal was submitted by you and Person A to the Council as a result of their request that the land be rezoned. The Council notified you that your application to rezone the Land had been received in the year after the rezoning proposal had been submitted. Around seven months later, the rezoning of the Land was gazetted by the relevant Government authority. In the same year that the rezoning of the Land was gazetted, the Council issued an Amendment of the Shire Planning Scheme (the Amendment) which applied to the entire Shire as part of the adopted Plan previously issued, and the subsequent Local Planning Policy Framework (LPPF) review. Under the amendment, the Land was rezoned from Low Density Residential Zone to General Residential Zone. Due to your ill health, you are unable to manage the stock or the demands of maintaining the Land and you and Person A have decided to review and explore all potential options in relation to the land's future. You and Person A approached a local real estate agent with the view to selling the Land to a potential developer without any need to undertake a joint venture. During your initial meeting with a real estate agent (the Agent), you requested that the Land be inspected and that the Agent liaise with their colleagues to determine a realistic selling price for the Land. The Agent estimated that the Land was valued at over $X,000,000. From 201X to the present, the Land has been marketed by the Agent's firm who have advertised the Land on the internet and have contacted local land developers to assess any potential interest in purchasing the Land. The Agent's firm had not received any offers to purchase the Land in full, but had received multiple joint venture offers from developers offering up to $X,000,000 if you and Person A would provide them upfront access to develop the Land for a small nominal deposit. Other offers requested that you transfer the ownership of the Land to them upfront so that they could secure funding to move forward with the development. You and Person A did not accept these offers as the developers were not known to you and the developers did not have the financial backing to undertake the purchase of the Land. Larger building companies were contacted, however they did not express any interest in purchasing the Land as they were seeking larger parcels of land to maximise their profit margins. In 201X, you were approached by a local land developer (the Developer), who is a local building development company with experience in developing housing estates, small hospitals and schools and whose owners are known to both you and Person A. You estimate that the market value of the Land just prior to your meeting with the Developer was over $X,000,000. During your initial meetings with the Developer, you and Person A outlined the terms and conditions of your proposal, inclusive of the need to receive a non-negotiable agreed total amount on the sale of the subdivided lots and that the Developer would be responsible for all costs. Following this meeting, the Developer undertook feasibility analysis on the development of the Land. You and Person A have had several meetings with the Developer, and while no formal agreement has been signed, you and Person A have verbally agreed to the offer from the Developer where broadly the features and terms of that relationship are: • You and Person A will supply the land and the Developer will provide the expertise and all financial considerations to develop the Land to a point where over XX subdivided lots will be available for sale • You and Person A, as the owners of the Land, will retain the ownership of each subdivided lot until it is sold, when the ownership interest in the subdivided lots will be transferred to the purchasers • You and Person A will be paid around $X,X00,000 in instalments from the proceeds on the sale of each of the subdivided lots prior to development and management costs being deducted, with the Developer receiving the remaining proceeds • The Developer will be responsible for the development of the site, all of the infrastructure, and the marketing of each subdivided lot by their preferred real estate agent • The subdivision will be undertaken in either two or three phases to ensure ongoing financial viability for the Developer • The Developer will be responsible for obtaining all Council and regulatory approval for the subdivision • The Developer has estimated that it may take up to two years to gain all necessary Council and regulatory approvals before the subdivision can commence • You and Person A will meet with the Developer on a regular basis to receive updates such as: • Progress since previous meeting • Issued identified/encountered and actions taken • Feedback from Council and regulatory bodies; and • Feedback from neighbours. It is estimated that the subdivided lots will be sold for over $X00,000 with the development cost of over $X0,000 per lot. The subdivision of the Land will be undertaken in numerous stages. You and Person A will not personally be undertaking any activities in relation to the subdivision of the property. For the purposes of this ruling the following will occur: • You and Person A will engage the services of professionals (the Developer) to undertake all of the activities in relation to the subdivision and manage and co-ordinate the subdivision of the Land • The Land will be subdivided into over XX subdivided lots • The Developer will finance the subdivision of the Land • You and Person A will receive around $X,X00,000 in instalments, paid from the proceeds of the sale of each subdivided lot as it is sold • You and Person A will not personally undertake any activities in relation to the subdivision of the Land • The Developer will engage the services of a real estate agent to market and sell the subdivided lots • The subdivision of the Land will be undertaken in numerous stages; and • Neither you nor any related associated have engaged in any similar activities in the past and do not intend to undertake similar activities in the future.

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

Reasons for decision: Summary: Legislative references referred to herein are from the ITAA 1997 . 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. There have been several cases in which the courts have addressed the question of whether the proceeds received for the sale of an asset are revenue or capital in nature. The decision in each case depended on its own facts, and very often will be a matter of degree. The extent of the personal involvement of the taxpayer in much of the planning, organisation and management of the activities has been held to be significant factors in the determination of whether or not a business was being carried out. For example: • In Stevenson v FC of T (1991) 91 ATC 4476; (1991) 22 ATR 56; (1991) 29 FCR 282 (Stevenson) the degree of the taxpayer's involvement was seen as an indicator of a business being conducted; and • The lack of personal taxpayer involvement was seen as a relevant to the finding that a business was not being conducted in the cases of Stratham V FCT 89 ATC 4070, McCorkell v FCT 98 ATC 2199 (McCorkell) and Casimaty v FCT 97 ATC 5 (Casimaty). From the cases involving the subdivision of land and from Taxation Ruling TR 92/3 (TR 92/3), it would appear that the following are the most important factors to consider when determining whether profits made as a result of an isolated business transaction are assessable income: (a) the intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain; and (b) the transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. In determining whether an isolated transaction amounts to a business operation or commercial transaction the following factors are relevant: 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. 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. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment. Application to your situation In your case, you inherited your ownership interest in the Land when Parent B passed away. The Land has been used for farming activity from the time it was transferred into you and Person A's names until the present time. The local Council had rezoned the Land to Residential 2 prior to 2010. A number of years later the Council had identified that due to the Land's location within the local Shire's Growth boundary, that the Land had been identified as being land to be rezoned to General Residential 1. The Council had encouraged you and Person A to have the Land rezoned and around three years after you had inherited the Land a rezoning proposal had been submitted to the Council. The rezoning of the Land had been gazetted during the following year after the proposal had been submitted. Due to your health, a local real estate agent had been approached over four years after Parent B had passed away, with a view of selling the Land. The Land was put on the market from that time until the present time. No offers to purchase the Land in full were received, however numerous offers were received from developers offering up to $X,000,000 if you and Person A would provide them with upfront access to develop the Land for a small nominal deposit. You also received other offers in which you and Person A were requested to transfer the ownership of the Land to them upfront so that they could secure funding to develop the Land. You did not accept any of these offers. Larger building companies had not expressed any interest in purchasing the Land as they were seeking larger parcels of land to maximise their profit margins. Over five years after Parent B passed away, you were approached by the Developer, with whom you have had meetings with in relation to the subdivision of the Land. You and Person A have not signed a formal contract but you have verbally agreed to an offer from the Developer under which: • You and Person A will supply the Land which will be subdivided into over XX lots • You and Person A will receive around $X,X00,000 in instalments paid out of the proceeds from the sale of the lots prior to any other costs being paid • The Developer will be responsible for the development of the site, all of the infrastructure, and the marketing of each subdivided lot by their preferred real estate agent • The subdivision will be undertaken in numerous phases to ensure ongoing financial viability for the Developer; and • The Developer will be responsible for obtaining all Council and regulatory approval for the subdivision. The market value of the Land is over $X,000,000 and it is estimated that the subdivided lots will be sold for over $X00,000 and will have a development cost of over $X0,000 per lot. No other subdivision activities have been undertaken by you in the past and you do not intend to undertake any similar activities in the future. Based on the information provided, there is nothing to suggest that the subdivision of the Land was the beginning of a continuing business of property subdivision. Your 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 your activities in relation to the subdivision of the Land are not those of an entity carrying on a business of buying, subdividing and selling subdivided land. Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the subdivision of the Land and sale of the subdivided lots will not be considered commercial in nature but will be a mere realisation of a capital asset, being a long-held privately owned property. In conclusion, the activities involved in the subdivision and 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 subdivision activities will become a separate business operation or commercial transaction, or that you will be carrying on, or carrying out a profit-making undertaking or plan. Therefore, as it is not viewed that you are carrying on a business, or that the subdivision activities will be an isolated transaction, any profit arising from the sale of the subdivided lots will not be assessable under section 6-5. | Detailed Reasoning - Mere realisation: 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. When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided lots is not a CGT event, according to subsection 112-25(2). Each new subdivided lot will be viewed as having been acquired on the same date that the original asset was acquired. The mere realisation of a capital asset has been described as "liquidating or realising the old assets" ( Commissioner of Taxes v Melbourne Trust Limited [1914] AC 1001). In the High Court of Australia case of Federal Commissioner of Taxation v NF Williams 72 ATC 4188; (1972) 127 CLR 226, at ATC 4194-4195; CLR 249, Gibbs J explained mere realisation of land as follows: An owner of land who holds it until the price of land has risen and then subdivides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of subdivision and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realization of a capital asset are not income either in accordance with ordinary concepts…even though the realization is carried out in an enterprising way so as to secure the best price… In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135, at 97 ATC 5152, Ryan J described a salient characteristic of the mere realisation of land as follows: …[to not] undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. In distinguishing mere realisation from a commercial transaction, Ryan J further said: Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. Application to your situation In this case, you inherited your ownership interest in the Land when Parent B passed away. You intend using the services of a Developer to subdivide the Land into over XX subdivided lots which will be sold. As your activities are not viewed as being either those of someone carrying on a business of subdivision and sale of land, or undertaking an activity of a commercial nature, it is considered that any gain made on the disposal of your ownership interest in the subdivided lots will represent a mere realisation of the Land to its best advantage. Therefore, any gain arising from the sale of your ownership interest in the subdivided lots will be accounted for under the CGT provisions in Part 3-1. Each of the subdivided lots being viewed as having been acquired on the same date that the Land was acquired and any capital gain made on the sale of the subdivided lots will be calculated in accordance with the CGT provisions.