Private ruling: Property subdivision - profit from isolated transaction
Date of advice: 2 August 2018
Published: September 2018
Ruling period: Year ending 30 June 2018 | Year ending 30 June 2019
Date scheme commenced: 1 July 2017

Ruling: Q1: Will the profit made on the disposal of unit ‘two’ be assessable under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the sale of unit ‘two’ be a mere realisation, with the result that the sale proceeds from the sale are only on capital account? | A2: No. | Q3: Do you need to have a current market valuation of the property prior to commencement of construction? | A3: No | Q4: Under section 118-20 of the ITAA 1997, are you entitled to reduce any capital gains made by the disposal of unit ‘two’ by any amounts which are included in your assessable income under 6-5 of the ITAA 1997 | A4: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 section 6-5 | Income Tax Assessment Act 1997 section 10-5 | Income Tax Assessment Act 1997 section 102-5 | Income Tax Assessment Act 1997 section 104-10 | Income Tax Assessment Act 1997 section 112-25 | Income Tax Assessment Act 1997 section 118-20

Reasons for decision: Summary: There are three ways profits from a land subdivision 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. 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. 3. As statutory income under the capital gains tax (CGT) legislation, (sections 10-5 and 102-5 of the ITAA 1997), on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Ordinary income: In your situation, the Commissioner is satisfied you are not carrying on a business of property development. The repetition, scale and volume of your activity is not of the same nature as is ordinarily carried on by a property developer that is carrying on a business. Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 defines the term ‘isolated transactions’ as: ● transactions outside the ordinary course of business of a taxpayer carrying on a business; and ● transactions entered into by non-business taxpayers. 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. It is sufficient if profit-making is a significant purpose. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: ● the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and ● the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: 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. In the Federal Court of Australia case of Casimaty v Federal Commissioner of Taxation 97 ATC 5135 ( Casimaty ), the legal principles in relation to the subdivision of land were discussed at length. In concluding his judgment that the subdivision of the taxpayer was a mere realisation of a capital asset, Justice Ryan said, at 97 ATC 5152: Nor did the taxpayer 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. 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. [Emphasis added] In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: n there is a change of purpose for which the land is held; n additional land is acquired to be added to the original parcel of land; n the parcel of land is brought into account as a business asset; n there is a coherent plan for the subdivision of the land; n there is a business organisation – for example a manager, office and letterhead; n borrowed funds financed the acquisition or subdivision; n interest on money borrowed to defray subdivisional costs was claimed as a business expense; n there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and n buildings have been erected on the land. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. | Detailed Reasoning - Application to your circumstances: In your case, you acquired a property that you lived in as your main residence a number of years ago. You will subdivide the land into two separate blocks. One block will contain your newly constructed main residence and a separate unit constructed on the remaining subdivided block. In accordance with the direction provided in TR 92/3 and MT 2006/1 we consider that the activities amount to more than the mere realisation of an asset to its best advantage. There is a coherent plan in place to carry out a sequence of actions that will result in a profit, there is a change of purpose for which the land is held as the land was originally held as your main residence. There is a level of development of the land beyond that necessary to secure council approval for a subdivision and buildings have been erected on the subdivided land. You may also borrow money to finance the development. On a weighing of the facts of your case we find that the subdivision and construction of unit two will constitute an isolated profit-making scheme. Accordingly the profits from the transaction will be considered ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Market Value: It is reasonable for the market value of the land at the time the profit making undertaking commenced to be used when determining the profit or loss made on the sale of unit two. Detailed reasoning When a property development activity is a one-off profitmaking undertaking, a taxing point will only be triggered when the relevant property/ies are sold. As a general proposition, the capital gain from the time the property was originally acquired to the point at which the project became revenue in nature, the time of conversion, will continue to be subject to CGT while the amount by which the sale price of the subdivided lots exceeds the market value of the land at the time of conversion and other development costs will be subject to full income tax. Therefore, a market valuation of the property at the time of conversion would be considered to be a reasonable time when determining the profit/loss made on the sale of a property sold as a result of a profit making undertaking. Application to your situation In your case, the nature of the land changed from being a capital asset to being on revenue account when the profit making undertaking is ventured into this is when the market value needs to be determined. | Detailed Reasoning - Capital gains tax: Capital gains tax (CGT) is the tax that you pay on certain gains you make. You may make a capital gain as a result of a CGT event, happening to an asset in which you have an ownership interest. The most common CGT event, CGT event A1 (section 104-10 of the ITAA 1997), occurs when you dispose of your ownership interest in a CGT asset to another entity. Under section 112-25 of the ITAA 1997, the subdivision of land does not result in a CGT event. As such, you are not making a capital gain or capital loss at the time of the subdivision. You make a capital gain or loss at the time you enter into the contract for the disposal of the subdivided land and unit or when there is a change in ownership. Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 occurred due to the sale of unit ‘two’, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.

Relevant facts: ‘A’ and ‘B’ (you) purchased their primary residence after 20 September 1985. | You submitted an application (which has been approved) to the local council to subdivide the land into two lots and build a unit on each of the separate titles. | You will demolish the property in 2018 to start construction of the two units soon after. | You will live in unit one, after construction, as your primary residence and sell unit two in the near future to recoup some of the cost of construction. | You are not currently engaged in land and property development. | You have never been engaged in land & property development in your individual names in the past and do not intend to be engaged in such activities in the future. | The financing of the units by way of a business loan is not being considered. No arrangements have been made to date about how the construction of the project will be financed. | No contractual arrangements have been made to date but: | ● a registered builder will be engaged to build the units; | ● a real estate agent may eventually be engaged upon completion of the units to sell unit two. | You have not engaged the services of a surveyor. However, these services may be required in the future. | The council planning permit required power, water, telephone and gas connections. | Road access considerations were also part of the council planning permit. | A storm water management plan formed part of the council planning permit. | A landscape plan, a stormwater plan, street tree protection, parking and traffic management, infrastructure and road works conditions had to be satisfied to obtain the development approval. | Assumptions: For the purpose of this ruling unit ‘two’ will be sold for a profit.