Private ruling: Capital gains tax – subdivision – development – capital vs income
Date of advice: 13 June 2018
Published: August 2018
Ruling period: Income year ending 30 June 2018 | Income year ending 30 June 2019 | Income year ending 30 June 2020 | Income year ending 30 June 2021 | Income year ending 30 June 2022
Date scheme commenced: 1 July 2017.

Ruling: Q1: Will any gains made on the disposal of Lot C and Lot E only be assessable under Parts 3-1 and 3-3 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the gain made on the sale of Lot D only be assessable under Parts 3-1 and 3-3 of the ITAA 1997? | A2: No. While a capital gains tax event will occur on the disposal of Lot D, the profit will be assessable firstly under section 6-5 of the ITAA 1997. If there is any capital gain amount over the amount assessed under section 6-5 of the ITAA 1997, it will be assessed under Parts 3-1 and 3-3 of the ITAA 1997. | Q3: Will the capital proceeds received for the disposal of Lot C be equal to the $XXX,XXX charged by Person A as the cost of constructing the townhouse of Lot B? | A3: Yes. | Q4: Will the capital proceeds received for the disposal of Lot E be equal to the $XXX,XXX charged by Company XYZ as the cost of constructing the townhouse on Lot A? | A4: Yes. | Q5: Will the first element of the cost bases of Lot C and Lot E be the apportioned cost bases of the original property? | A5: Yes.

Relevant facts and circumstances: You and your partner, Person X, purchase the property (the Property) as joint tenants after 20 September 1985 for $XXX,XXX. The land area of the Property is XXX square metres. A number of structures were located on the Property which had been constructed prior to 20 September 1985. Your intention was to renovate one of the structures (the House) located on the Property to live as your main residence, and to repair the other structure (the Structure) for your partner’s child to live in. The House and Structure were tenanted when the Property was purchased and they continued to reside there after the purchase. The House and Structure were rented until the funds for the repairs and renovations were obtained. A number of years after the Property was purchased the repairs to the Structure were undertaken. Your partner’s child moved interstate so the Structure was rented out a number of months after the repairs were completed. The House continued to be rented out while the repairs on the Structure were being completed. In the following year you commenced obtaining plans and quotes to renovate the House. The permits were obtained and the renovation of the House commenced in early the following year. Your partner passed away and their ownership interest in the Property was transferred into your name. You continued with the House renovations, which were completed a number of months after your partner has passed away, when you moved into the House. You continued to reside in the House for a number of years when you moved to another property you owned and it was tenanted out shortly after. The Property was valued at $XXX,XXX in the income year in which you commenced renting it out. You have charged the total gross rent of approximately $XX,XXX per annum for the House and Structure. The current tenants in the House and/or Structure have been issued with notices to vacate both premises. You decided that you would like to replace the existing structures due to their state of dilapidation, and to resume residing at the Property. Your retirement is approaching and you do not want to take on significant debt or undertake the necessary works yourself. You had discussions with a representative from Company XYZ in relation to the potential redevelopment of the Property. At Company XYZ’s recommendation you requested them to prepare an application for a planning permit for a number of townhouses on the Property. Company XYZ’s director expressed an interest in acquiring part of the Property land (the Land) and had advised you of a builder they knew, being Person A, who would be suitable to construct the townhouses and who would also be interested in acquiring part of the Land. It was agreed by you and Company XYZ that Company XYZ would: ● make the application for the planning permit with the cost being shared ● manage the redevelopment itself, or through another entity ● would provide the following services: ● architectural drawings; ● preparing applications and obtaining the planning and building permits; ● subdividing the Property; ● appointing and instructing all technical and legal consultants; ● appointing the builder and negotiation of all building contracts; ● managing the construction phase, including negotiations with the builder; and ● payment of half of the consultant costs to the date of the planning permit being granted and payment of all consultant costs. Company XYZ prepared a town planning application for the Property and lodged it with the local council. A Development Agreement (the Agreement) was prepared and signed on the same day. The following information has been sourced from the Agreement: ● the Agreement is made between you (Owner), Company XYZ (Development Manager) and Person A (Builder); ● the Owner agrees to make the Land available for the Development Manager to manage the development and the Builder to undertake the builder works; ● building works means all activities, tasks and work the Builder is or may be required to undertake in connection with the development including the construction of a single residential dwelling on each Lot, the completion of the common land and undertaking any remedial works or temporary work required to complete the development in accordance with the Agreement and Approvals; ● construction costs include the costs necessary for the completion of the building works including the cost of any necessary insurance and any relevant GST; ● the Builder will be responsible for financing the construction costs; ● the development and realisation of the land involves the subdivision of the land into five lots with common land to provide access and servicing to each of the townhouses ● the construction costs associated with works on common land will be evenly apportioned between Lots A, B, C and D; ● the Land will be subdivided into the Lots anytime It is estimated that the current value of the Property is around $X.X million based on council rates notice and other local sales. It is estimated that the value of the Land with the planning approval will be $X.X million with some of the lots of vacant land being valued at $XXX,XXX and the remaining lot being valued at $XXX,XXX. Financial estimates have been provided from which the following information has been sourced: Lot Nominal build cost Estimated sales Lot A $XXX,XXX $X,XXX,XXX to $X,XXX,XXX Lot B $XXX,XXX $X,XXX,XXX to $X,XXX,XXX Lot C $XXX,XXX $X,XXX,XXX to $X,XXX,XXX Lot D $XXX,XXX $X,XXX,XXX to $X,XXX,XXX Lot E $XXX,XXX $XXX,XXX to $XXX,XXX ● the estimated gross profit for Lot D is as follows: ● you - $XXX,XXX to $XXX,XXX; and ● Company XYZ- $XXX,XXX to $XXX,XXX ● distribution of the proceeds from the sale of Lot D will be made to Person A for the Total Construction Cost in relation to that lot; and ● distribution of the profit from the sale of Lot D will be made to Company XYZ. It is anticipated that: ● the Property will be subdivided into five lots (the Lots), being Lots A to E, with a townhouse to be constructed on each Lot; ● the House and Structure will be demolished; ● the subdivision plan will be lodged with the council with approval expected in the year after it is lodged; ● the contracts for the sale of proposed/subdivided Lots C and E will be entered into, which may be prior to the subdivision being approved if it is necessary for the construction of the townhouses to commence. Lot C will be sold for $XXX,XXX and Lot E will be sold for $XXX,XXX (being the construction costs of Lot A and Lot B); ● the construction cost of the townhouses will be $XXX,XXX for Lot A, $XXX,XXX for both Lot B and Lot D (with the transfer of Lots C and E being accepted as payment for these costs); ● you will pay for the construction of the townhouses on Lots A and B simultaneously with the settlement of the sale contracts for Lots C and E; ● from the date of the sale contracts, Company XYZ and Person A will be licenced to occupy their lots and build their own townhouses prior to settlement occurring; ● Company XYZ will enter into a construction contract with Person for $XXX,XXX to construct the townhouse on Lot E; ● Person A will ‘owner build’ on their own lot, being Lot C, with construction of townhouse estimated to be $XXX,XXX; ● Company XYZ, or its nominee, will fund the construction of the townhouse on Lot E; ● the construction of the townhouses are expected to occur around two years after the construction commences; ● you will not fund the construction of the townhouse on Lot D as it progresses. However, Lot D will be sold and you will pay the construction costs, expenses incurred in relation to its sale and developer’s fee from the proceeds of the sale of Lot D. Company XYZ will engage a real estate agent of its choice to market Lot D; ● you will retain the ownership of Lots A and B, residing in Lot A and will using Lot B as a long term investment property; and ● the Project should be concluded a number of years after it commences, however it is possible that the timeline will be extended if contingencies arise. You will not receive any proceeds from the demolition of the House and Structure. Neither you nor any related associate/s have undertaken any similar activities in the past and do not have any intentions to undertake any similar activities in the future. Assumptions For the purposes of this ruling decision: ● the actual construction costs of the townhouses will be reasonably consistent with the financial estimates provided with the private ruling application; and ● the activities will be undertaken in accordance with the Development Agreement.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | 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: Detailed Reasoning - Taxation treatment of property sales: There are three ways profits from property sales can be treated for taxation purposes: 1. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock; or 2. As ordinary income under section 6-5 of the ITAA 1997, on revenue account, as a result of an isolated business transaction entered into by a non-business taxpayer, or outside the ordinary course of business of a taxpayer carrying on a business, which is the commercial exploitation of an asset acquired for a profit making purpose; or 3. As statutory income under the capital gains tax legislation on the basis that a realisation of a capital asset has occurred. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. | Detailed Reasoning - Carrying on a business of property subdivision and/or development: 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. Application to your situation In this case, you and your then partner purchased the Property in about 1990. Your partner passed away and their ownership interest in the Property was transferred into your name in about 199X. The Property has been used as your main residence and as a rental property during various periods of your ownership periods. You are approaching retirement and have decided that you want to replace the House and Structure and resume living at the Property. It is proposed that the following will occur: ● the House and Structure will be demolished; ● the Property will be subdivided into five lots, being Lots A to E; ● you will sell Lot C, being vacant land to Person A, the Builder, who will fund the construction of their townhouse on that lot; ● you will sell Lot E, being vacant land, to Company XYZ’s nominee who will fund the construction of their townhouse on that lot; ● a townhouse will be constructed on Lot D which will be paid for out of the proceeds from its sale. Expenses incurred in relation to its sale and developer’s fees will also be paid out of the sale proceeds; ● you will keep Lot A, with the constructed townhouse, in which you will reside; and ● you will keep Lot B, with the constructed townhouse, which you will use as a long term investment property (the Project). You have engaged the services of Company XYZ who have prepared and lodged the planning permit for townhouses to be constructed on the subdivided lots. The services of Person A will be used to construct the townhouses on the lots. Neither you, nor any associates, have undertaken any similar activities in the past and do not have any intentions to undertake any similar activities in the future. Based on the information and documentation provided, there is nothing to suggest that the subdivision and development of the Property will be the beginning of a continuing business of property development as it will be a one-time project. Your activities do not display the salient indicator of a business, being transactions entered into on a continuous and repetitive basis. Therefore, any gain made on the disposal of Lots C, D and E will not be assessable income under section 6-5 of the ITAA 1997 as ordinary income from the carrying on of a business. | Detailed Reasoning - Profit making undertaking: 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. Whether a particular transaction has a business or commercial character depends very much on the circumstances of the case. Paragraph 13 of the ruling outlines the following factors which may be relevant when considering whether an isolated transaction amounts to a business operation or commercial transaction: ● 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 the property, and ● the timing of the transaction or the various steps in the transaction. Paragraphs 41 and 42 of TR 92/3 outline that where a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset into a profit-making undertaking or scheme with the characteristics of a business operation or commercial transaction, the activity of the taxpayer constitutes the carrying on of a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. In determining whether activities relating to isolated transactions are a profit making undertaking or are the realisation of a capital asset, it is necessary to examine the facts and circumstances of each particular case. This may require a consideration of the factors outlined above; however there may also be other relevant factors that need to be weighed up as part of the process of reaching an overall conclusion. No single factor will be determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. The direction provided within TR 92/3 indicates that profits in this context are more likely to be considered ordinary income if they are made in the ordinary course of carrying on a business. Further, ordinary income may be derived from an isolated transaction which becomes commercial in nature, or as a result of profits on a transaction in which the initial intention was to make a profit on sale. Application to your situation You have owned your ownership interests in the Property for a significant period of time. While you have used the Property for both private use as your main residence and for rental purposes during your ownership periods, your intention in relation to the Property has changed with the intention to undertaking the Project. We have made the following decisions in relation to Lots C, D and E: Lot D In relation to Lot D we have taken the following into consideration when determining whether the sale of this lot will be a profit making intention or will be the realisation of an asset: The undertaking of the demolition of the House and Structure, subdivision of the Property and construction of the townhouse on Lot D will involve significantly improving the value of that lot as opposed to if that lot was being sold as vacant land like Lots C and E. The nature of the Property will be changed from being a single title with structures located on it to five separate titles with a townhouse constructed on each subdivided lot. The estimated value of the property prior to the Project being undertaken was $X.X million and it is estimated that the sale value of Lot D alone will range from $X.X to $X.X million. The range of sale values as provided for Lot D alone are slightly less than the value of the whole property prior to the Project commencing. The simplest way you could have sold the Property was to sell it as a whole. However, there is a coherent plan of demolition, subdivision and construction of the townhouse on Lot D with the intention of selling it specifically for the purpose of making a profit. You have approached the Project in a businesslike way by seeking advice from Company XYZ in relation to the proposed activities. In very general terms the Project has the character of a business operation or commercial transaction and would constitute the carrying on of a business except that it will not occur as part of repetitious or recurring transactions or operations. The manner in which the Project has been entered into and will be carried out on your behalf has the nature of a commercial transaction. The development of the Property is not a simple and uninvolved development and your actions demonstrate that the development and sale of Lot D will be undertaken on the basis that it will be profitable and that a gain will be made on the disposal of Lot D. The construction of the townhouse on Lot D will not be undertaken for the purpose of private or rental purposes, but solely for the purpose of sale. Although your initial intention when you acquired the Property may have been for private purposes, as outlined in paragraph 42 of TR 92/3, when a taxpayer’s intention in relation to an asset changes and the taxpayer decides to venture into a profit-making scheme with the characteristics of a commercial transaction, the activity of the taxpayer will constitute the carrying out of a profit-making scheme. The objective evidence sourced from the information and documentation provided establishes that your intention in entering into the activities in relation to Lot D will be for the purpose of making a profit or gain from its sale from an isolated transaction. While you did not acquire your ownership interests in the Property for resale for a profit, your intention in relation to Lot D is to sell it. Accordingly, the proceeds from the sale of Lot D will be assessable as ordinary income under section 6-5 and not as statutory income under the capital gains tax provisions. Lot C and Lot E After the Property is subdivided, no improvements will be made to Lots C and E prior to their sale to increase their value. Unlike Lot D and they will be sold as vacant lots of land to Company XYZ and Person A. After weighing up the factors outlined in TR 92/3 and applying them to the facts of your situation we have determined that the profits arising from the sale of Lots C and E will not be on revenue account in relation a profit making undertaking. Therefore, any profit arising from the sale of Lots C and E will be accounted for under the capital gains tax provisions as a realisation of your assets. | Detailed Reasoning - Capital gains tax: The capital gains tax (CGT) provisions are contained in Parts 3-1 and 3-3 of the ITAA 1997. 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 two or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event. Where the original land was acquired after 20 September 1985, each new subdivided block retains its post-CGT status and will be viewed as having been acquired on the same date the original asset was acquired. 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. The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. Therefore, while a CGT event will occur when an asset is sold (CGT event A1), any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997. Application to your situation As outlined above, it is not viewed that the profit made on the disposal of Lots C and E will be assessable as a result of you carrying on a business or from a profit making undertaking. Therefore, any profit made on the disposal of Lots C and E will be assessable under Parts 3-1 and 3-3 of the ITAA 1997 as a realisation of your asset. Under the CGT provisions you are viewed as having acquired your original ownership interest in the Property in 1990, and acquired the remaining ownership interest in the Property when your partner passed away. Therefore, for CGT purposes you are viewed as having two separate CGT assets in the Property acquired when you obtained each of the ownership interests. No CGT event will occur when the Property is subdivided and all of the subdivided lots will be treated for CGT purposes as if they had been acquired when each of your ownership interests in the Property were acquired. That is, you will have ten separate CGT assets, with each subdivided lot consisting of two separate CGT assets in accordance with your ownership interests. The portion of each subdivided lot that relates to each of your ownership interests will be dependent on what percentage of ownership you acquired in both 1990 and 1993. When you dispose of your ownership interests in Lots C and E a CGT event A1 will occur. Note: CGT event A1 will also occur on the disposal of Lot D. However, as any profit made on the sale of that lot will be assessable under section 6-5 of the ITAA 1997, any capital gain will be reduced to the extent that the profit is included in your assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Capital proceeds: Capital proceeds from a CGT event are generally the total of the money you have received, or are entitled to receive, in respect of the event happening, and the market value of any other property you have received, or are entitled to receive, in respect of the event happening. You are considered to have received money or other property if it is applied for your benefit (including by discharging all or part of a debt you owe) or as you direct. Application to your situation In your situation: ● you will enter into a contract to construct a townhouse on Lot B, the cost is anticipated to be $XXX,XXX; ● you will transfer Lot C to Person A to pay the cost of constructing the townhouse on Lot B; ● you will enter into a contract to construct a townhouse on Lot A, the cost is anticipated to be $XXX,XXX; ● you will transfer Lot E to Company XYZ or its nominees to pay the cost of constructing the townhouse on Lot A; ● the contracts will be negotiated on your behalf by Company XYZ/Person A; and ● you state that no money will be transferred by any parties when settlement on the sale of Lots C and E occurs. Based on the information provided, it is viewed that the capital proceeds that you will receive on the sale of Lots C and E will be equal to the costs to construct the townhouses on Lots A and B. That is, your capital proceeds for: ● Lot C will be equal to the cost to construct the townhouse on Lot B; and ● Lot E will be equal to the cost to construct the townhouse on Lot A | Detailed Reasoning - Cost base of land after the demolition of a dwelling: CGT event C1 happens if a CGT asset you own is lost or destroyed, such as on the demolition of a dwelling. When no capital proceeds are received on the demolition of a dwelling, no amount is apportioned to the cost base or reduced cost base of the dwelling. Therefore, upon demolition of the dwelling the original cost base of the land and dwelling is wholly attributable to the land. Note: If a building is demolished, there is no deemed market value consideration for the disposal that occurs as a result of the demolition. This is because the market value substitution rules do not apply where CGT event C1 occurs. Application to your situation In this case, the House and Structure on the Property will be demolished and CGT event C1 will occur. You will not receive any proceeds in relation to the disposal of those structures. As you are not receiving any proceeds from the demolition of the structures, no cost base will be attributed to the House and Structure, and there will be no capital gain or capital loss made on their demolition. The original cost base of each of your ownership interests in the Property will be attributed solely to the land of the Property. | Detailed Reasoning - Cost base of subdivided land: When land is subdivided the cost base of the original land should be apportioned on a reasonable basis between the subdivided blocks. A reasonable apportionment of the original cost of the land can usually be achieved on an area basis if all the land is of similar size and market value or on a relative market value basis if this is not the case. If the blocks are of unequal market value the costs such as survey, legal fees and application fees associated with the subdivision should be apportioned in accordance with relative market values of the blocks. Application to your situation As outlined above: ● the original cost base of both of your ownership interests in the Property will be solely attributable to the Property land when the House and Structure are demolished; and ● when the Property is subdivided, you will have two separate CGT assets in each subdivided lot, that is you will have 10 CGT assets. Your original ownership interest in the Property will have one cost base while your ownership interest acquired from your partner will have a different cost base. When the Property is subdivided, you will need to apportion the cost bases of the Property land in relation to both of your ownership interests between the five subdivided lots on a reasonable basis as outlined in Taxation Determination TD 97/3 . Note: There are no CGT provisions or legislation that would allow the market value of the land prior to the subdivision to be used as the cost base of the subdivided blocks of land.