Private ruling: Capital gains tax - subdivision - revenue v capital
Date of advice: 8 November 2017
Published: April 2018
Ruling period: Income year ending 30 June 2018
Date scheme commenced: 1 July 2017.

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 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: Yes. | 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 as a result of a realisation of a capital asset? | A3: Yes. However, section 118-20 of the ITAA 1997 will apply to reduce the capital gain to the extent that the profit from the sale of the subdivided lots is otherwise included as assessable income under section 6-5 of the ITAA 1997. | Q4: Does the development and sale of the blocks of land which currently form part of your principal place of residence constitute an enterprise? | A4: Yes.


Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 118-20 | Income Tax Assessment Act 1997 Section 995-1 | Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 Part 3-3 | A New Tax System (Goods and Services Tax) Act 1999 section 9-20 | A New Tax System (Goods and Services Tax) Act 1999 section 23-5

Reasons for decision: Detailed Reasoning - Taxation treatment of property sales: Broadly, there are three ways profits from a land development, subdivision and sale can be treated for taxation purposes: ● as ordinary income on revenue account, as a result of carrying on a business of property development, involving the sale of land and buildings as trading stock; ● as ordinary income 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, where the land was acquired or subsequently held for the purpose profit making; or ● as statutory income under the capital gains tax legislation on the basis that a realisation of a capital asset has occurred. | Detailed Reasoning - The change of intention: While holding an asset for a considerable period of time may seem to indicate that it is a long term capital asset, the intention of the taxpayer at the time of acquisition and throughout the ownership period is a crucial aspect. Numerous cases have considered the assessability of profits or proceeds from the sale of land including the following cases: Whitfords Beach Pty Ltd v Federal Commissioner of Taxation (1983) 14 ATR 247 where the taxpayer acquired 1.584 acres of land for non- commercial purposes. Thirteen years later, the original shareholders sold out and the company and the new ownership adopted an entirely new set of articles. It then embarked on a long and complex course of activity which involved the land being rezoned and developed as a residential subdivision. Vacant lots were sold over a period of many years for a substantial profit. The High Court held that the adoption of a new set of articles resulted in a change in the intended usage of the land. This resulted in the taxpayer’s activities going beyond the realisation of a capital asset, with the activities constituting the carrying on of an actual business of subdividing and selling land. Statham & Anor v. FC of T 89 ATC 4070 20 ATR 228 (Statham’s case) where the property was subdivided and sold after a business of raising cattle had failed. The taxpayer relied on the local council to carry out the subdivision work and the local real estate agents handled the advertising and sale of the lots. The Full Federal Court held that what occurred was the realisation, by the most advantageous means, of the asset which the owners had on their hands when they abandoned the intention of farming the subject property. Casimaty v FC of T 97 ATC 5135; (1997) 37 ATR 358 (Casimaty's case) where due to the growing debt and the ill health of the taxpayer, primary production land was progressively subdivided and sold off over a period of 18 years. There was no coherent plan conceived for the subdivision of the whole property. The taxpayer had acquired and had continued to hold and use the residence and conduct the business of a primary producer on the property. Therefore, there was no change of purpose of object for which the property had been held. In his judgment, Ryan J in the Federal Court held that the profits resulted from the mere realisation of a capital asset and as such the profits were not assessable as ordinary income. Stevenson v. Federal Commissioner of Taxation (1991) 29 FCR 282 91 ATC 4476 22 ATR 56 (Stevenson case) where taxpayer had owned farming land for many years, selling a portion of the land to a third party to be used for agricultural purposes. In the early 1970’s he decided to scale back his farming activities and sell most of the remaining 90 acres, other than a few acres retained for his use. He could not source a developer who would pay his sale price and in 1976 he determined that he would subdivide the land himself. He commenced subdividing the land in stages, obtaining finance and personally arranging for the construction of the necessary earthworks, storm water drains, guttered road works and other improvements to the land. Around the same time his farming income consisted of mainly agistment income. Throughout the process the taxpayer had personally dealt with councils, engineers, and statutory utilities. He advertised the development himself, did not engage the services of any particular real estate agent to assist him, dealt personally with prospective purchasers, did some of the physical work himself and fixed the sale price for the subdivided lots, being 220 lots. It was held that the taxpayer was carrying on a business of developing land. As displayed in the above cases, a taxpayer can embark on a profit making scheme or the carrying on of a business after property was acquired for a different purpose. We will consider whether the project will be viewed as the carrying on of a business, the undertaking a profit making activity or the realising a capital asset when the Property is subdivided and the sale lots are sold as follows: | Detailed Reasoning - Carrying on a business of property development: Section 995 of the ITAA 1997 states the term ‘business’ includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. The question of 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 TR 97/11 (TR 97/11) provides the Commissioner’s view of the factors used to determine if you are in business for tax purposes. In the Commissioner’s view, the factors that are considered important in determining the question of business activity are: ● whether the activity has a significant commercial purpose or character ● whether the taxpayer has more than just an intention to engage in business ● whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity ● whether there is regularity and repetition of the activity ● whether the activity is of the same kind and carried on in a similar manner to that of ordinary trade in that line of business ● whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit ● the size, scale and permanency of the activity, and ● whether the activity is better described as a hobby, a form of recreation or sporting 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 flavour. | Detailed Reasoning - Application to your situation: You acquired the property a number of years ago and have now made the decision to subdivide the property and sell the sale lots, with you retaining one of the proposed subdivided lots containing your main residence. In this case you have not previously undertaken any similar subdivision activities in the past and do not have any intention to undertake any similar activities in the future. You will fund the subdivision activities, take part in the management of the subdivision activities and will engage the services of a real estate agent/s to sell the sale lots. After reviewing the information and documentation provided, it is the Commissioner’s view that activities arising in relation to the project are not those of an entity carrying on a business of developing and selling property. While you are undertaking some of the activities in relation to the project, they are not of the level or scale as those undertaken by the taxpayer in the Stevenson case. Additionally, the activities undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. This is a small, one off project that is not being carried out in a manner similar to other property development businesses. Therefore, any profit made on the disposal of the sale lots will not be assessable as ordinary income from the carrying on of a business. We will consider whether or not the profits from the sale of the sale lots will be viewed as being received in relation to a profit making undertaking or a realisation of a capital asset as follows: | Detailed Reasoning - Isolated business transactions: 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 (TR 92/3) considers the principles outlined in Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 as ordinary income. Paragraph 1 of TR 92/3 outlines that isolated transactions are: a) those transactions outside the ordinary course of business of a taxpayer carrying on a business; and b) those transactions entered into by non-business taxpayers. TR 92/3 outlines that the relevant intention or purpose of the taxpayer, of making a profit or gain, is not the subjective intention or purpose of the taxpayer. Rather, it is the taxpayer’s intention or purpose discerned from an objective consideration of the facts and circumstances of the case. Paragraph 13 of TR 92/3 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. If a transaction or operation is outside the ordinary course of a taxpayer’s business, the intention or purpose of profit-making must exist in relation to the transaction or operation in question. 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 addition to the above factors, for the purposes of determining whether the activities undertaken in relation to real property and development equate to a profit-making undertaking or scheme, Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) aligns itself with TR 92/3 and provides a list of factors which, if present may be an indication that a business or profit-making undertaking or scheme is being carried on. 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. In the context of considering the above authorities and factors when determining whether the Project would be viewed as a profit making undertaking, the following general observations have been made: ● there is a coherent plan for the subdivision of the property into a number of lots which is more complex than what would have been involved in the disposal of the land as a whole. The simplest way you could have reduced your land holding would have been to dispose of the adjoining land as a whole property, potentially for a reduced price; ● you made the decision to subdivide the whole property unlike the taxpayer in the Casimaty case who subdivided his property in pieces and had never contemplated subdividing the whole property; ● there has been a change in the nature of the property with the proposed subdivision transforming the property from the existing main residence into smaller lots for new residential housing purposes; ● neither you, nor any related entities have been involved in similar activities in the past and do not have any plans to undertake any similar activities in the future. ● the market value of the property unsubdivided was estimated to be in $X Million, with the subdivision costs estimated to be $Y Million. Based on those figures, the cost to subdivide the Property will be more than the market value of the unsubdivided value of the property; ● the proceeds for the lots is estimated to be an amount. ● there is a demonstrated intention to profit from the subdivision of the property and the transaction has been undertaken in a commercial manner. ● You are borrowing an amount to fund the subdivision of the property. ● You have engaged the services of various professionals who will undertake various activities in relation to the subdivision. ● You will engage the services of a real estate agent to market and sell the sale lots. A balanced view of these observations, with no one feature being determinative in isolation, reasonably leads to a conclusion the intention for holding the property has changed upon the commencement of the subdivision activities to a profit making undertaking. The intention in relation to the property changed when you committed to this one-off undertaking in relation to the subdivision of the property and the proposed sale of the sale lots. The decision to pursue the subdivision shows your choice to engage in exposure to the risks of the development, including the profits, losses and its general success for the purpose of maximising the potential profit made on the sale of the sale lots. You are funding the subdivision by borrowing funds. You are incurring the risks involved with the subdivision and will have ultimate control of the subdivision activities. However, as outlined above, the facts of this situation are not the same as those of the taxpayer in the Stevenson case. This situation is also not like the Casimaty case as you plan to subdivide the whole property as opposed to the piecemeal subdivision of the property undertaken in that case. Additionally, your situation is not the same as the Statham case where the council had undertaken all of the work relating to the subdivision of the property as they will manage and control the project, engaging the services of the relevant entities to undertake the activities arising in relation to the project. It is viewed that the subdivision activity is of a sufficient scale to characterise it as a commercial or profit-making undertaking. We have determined that based on the facts of this situation that the project will be a profit making undertaking and the profits from the sale of the sale lots will be considered to be ordinary income and will be assessable under section 6-5 of the ITAA 1997. | 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 under section 104-10 of the ITAA 1997 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. Section 118-20 of the ITAA 1997 contains anti-overlap provisions which operate to reduce any capital gains by any amounts which are included in your assessable income under a provision of the ITAA outside of Part 3-1 as a result of the sale. Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner’s view that the subdivision and sale of the sale lots will not be a realisation of capital assets. Therefore, as the disposal of the sale lots is viewed as an isolated transaction, any profit made on their sale will be included in your assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Application to your situation: CGT event A1 will occur on the disposal of your ownership interests in each of the sale lots. The capital gain for the event is worked out by comparing the cost base of their ownership interests in the asset with the capital proceeds for its disposal. If the conditions under Division 115 of the ITAA 1997 are met, the capital gain can be reduced by 50% by applying the CGT discount. Any capital gain made on the disposal of the sale lots will be reduced to the extent that the profit from the sale of the sale lots is included in your assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Are you carrying on a business?: Section 9-20 of the A New Tax System (Goods and Services Tax) Act 1999 (GST Act) provides the definition of enterprise for GST purposes. This definition includes an activity or series of activities done in the form of a business; or in the form of an adventure or concern in the nature of trade. Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) considers the meaning of the word 'enterprise' for the purpose of entities' entitlement to an Australian business number (ABN). Goods and Services Tax Determination GSTD 2006/6 confirms that the principles in MT 2006/1 apply equally to the term enterprise for GST purposes. MT 2006/1 provides that ordinarily, the term business would encompass trade engaged in, on a regular or continuous basis. However, an enterprise can incorporate a single undertaking such as the acquisition, development and sale of real property. The definition of ‘business’ in section 195-1 of the GST Act is the same as that in section 995-1 of the Income Tax Assessment Act 1997 . The meaning of ‘business’ is considered in Taxation Ruling TR 97/11 which discusses the main indicators of carrying on a business. In order to be conducted ‘in the form of a business’ the activities would need to have the essential appearance or characteristics of a business. In this case, the property was acquired by your late spouse as their principal place of residence. You acquired half of the property in 19xx and the other half in 20xx. From the time the land was acquired to now the land has always been used for private residential purposes. Further, you have never been involved in any business of land subdivision and it is not anticipated that you will ever become involved in any land subdivision activity. We consider that you are not carrying on a property development business as you do not seem to be engaged in developing properties on a regular or continuous basis. | Detailed Reasoning - Carrying on an enterprise: However, the term ‘enterprise’ also includes an activity or series of activities carried on ‘in the form of an adventure or concern in the nature of trade’. An adventure or concern in the nature of trade may include isolated transactions that do not amount to a business, but which have the characteristics of a business deal. Paragraphs 262 to 302 of MT 2006/1 deal with isolated transaction and sales of real property. The ruling provides that often the question of whether an entity is carrying on an enterprise arises where there is a one-off activity or isolated real property transaction. The issue to be decided in such cases is whether the one-off activity is of a revenue nature (an enterprise) or a mere realisation of a capital asset. Paragraph 265 of MT 2006/1 provides guidance for determining whether activities involving the sale of real estate are a business or an adventure or concern in the nature of trade as opposed to a mere realisation of a capital asset. It states: 265. From the Statham and Casimaty cases a list of factors can be ascertained that provide assistance in determining whether activities are a business or an adventure or concern in the nature of trade (a profit-making undertaking or scheme being the Australian equivalent, see paragraphs 233 to 242 of this Ruling). If several of these 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: ● there is a change of purpose for which the land is held; ● additional land is acquired to be added to the original parcel of land; ● the parcel of land is brought into account as a business asset; ● there is a coherent plan for the subdivision of the land; ● there is a business organisation for example a manager, office and letterhead; ● borrowed funds financed the acquisition or subdivision; ● interest on money borrowed to defray subdivisional costs was claimed as a business expense; ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision; and ● buildings have been erected on the land. In this case the following factors were found to be present: ● there is a change of purpose for which the land is held; ● the parcel of land was brought into account as a business asset ● there is a coherent plan for the subdivision of the land ● Borrowed funds financed the acquisition or subdivision ● there is a level of development of the land beyond that necessary to secure council approval for the subdivision To recapitulate, paragraph 265 of MT 2006/1 provides a list of factors to determine whether activities are a business or an adventure or concern in the nature of trade. Paragraph 265 of MT 2006/1 further mentions that if several of these 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. In this case several of these factors are present. Consequently, we consider that your activities of land development are an adventure or concern in the nature of trade. | Detailed Reasoning - Are required to be registered for GST?: Section 23-5 of the GST Act provides that you are required to be registered for GST if you: (a) are carrying on an enterprise; and (b) you meet the registration turnover threshold. As determined above, you are carrying on a property development enterprise. Hence, you satisfy the requirement in paragraph 23-5(a) of the GST Act. Currently the GST turnover threshold is $75,000 ($150,000 for not for profit entities). As your turnover will be over $75,000 you will be required to be registered for GST.

Relevant facts: You and your spouse acquired a property (The property) | The property is greater than 2 hectares and is located in a residential growth area. | Your spouse passed away in 2014. You acquired your spouse’s share in the property so that you are now the sole owner of the property. The land was purchased by your spouse prior to 20 September 1985. | The property is your main residence. | The gardens require maintenance and it is becoming time consuming for you to undertake personally. | You have investigated selling some of the land as it is no longer required. You were recommended to discuss your options with a local developer, ‘A’. | The following information has been provided in relation to the local council plans in relation to your property: | ‘A’ lodged a development application with council in 2016. The decision of the council concerning ‘A’ submission was to approve the subdivision of the land as the approach was consistent with the council’s planning scheme. The area to be retained by you is as described above, namely Limited Development Landscape Residential. It cannot be developed further. | The plan of subdivision was approved in 2017. The plan provides for certain number of lot subdivision. | ‘A’ is an experienced engineer who specialises in the local area. ‘A’ has outsourced various technical aspects to consultants. Remuneration is based on an hourly and quote basis. The costs incurred to date are approximately an amount. | ‘A’ will arrange finance through their bank secured against the property. It is expected that the total costs of the subdivision will be approximately an amount. | The approximate market value of the property unsubdivided is an amount. | It is expected that the sale price of the subdivided lots will be between $X. to $Y. | You are required to build a sealed road to access the subdivided lots. | You are also required to provide electricity and services to the subdivided lots. | The subdivision activities are expected to start in 2017 and are planned to take a number of months to complete. | You will remain the registered owner of the land after the subdivision. | You have not entered into a development agreement with any party. | You will appoint 1 or 2 local real estate agents to sell the land and the negotiations will be undertaken by ‘A’. | You have not undertaken property development previously and do not plan on doing so in the future.