Private ruling: Capital gains tax - property - subdivision - carrying on a business - profit making undertaking - mere realisation
Date of advice: 12 April 2017
Published: September 2017
Ruling period: Income year ending 30 June 2017 | Income year ending 30 June 2018 | Income year ending 30 June 2019 | Income year ending 30 June 2020
Date scheme commenced: 1 July 2016.

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? | 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. Also, you disregard any capital gain to the extent that you acquired it prior to 20 September 1985.

Relevant facts and circumstances: Prior to 20 September 1985, you and your former spouse purchased the Property. The land area of the property is less than ten hectares. The boundary of the Property had been misinterpreted and as a result you and your former spouse purchased a parcel of land adjacent to the Property (the Land) from the same vendor. The Land was on a “conveyance” and not on a “fee simple title”. A short time later the title of the Land was issued. You had assumed that access to the Property was via a public road, however after you had purchased the Property you discovered that the Property was gated off by your neighbour (Person A) with no direct access to the Property. In the following year you approached the local council (the Council) for building approval for the construction of a house on the Property. The building approval was denied by the Council because you did not have a direct road frontage, or right of way. In the same year you and your former spouse separated resulting in you having custody of your child. You had commenced building a shed on the Property, and had built a house on the Property a number of years after your separation without Council approval, which became your main residence until the present time. You had discussions with Person A in relation to acquiring a right of way through his property. Person A is a property developer who intended subdividing their property, being the property through which the right of carriage would pass through. The right of carriage would be located where a proposed road (the Road) ending in a cul-de-sac would be located. Person A agreed to give you access via their property for the nominal sum of $XXX under the following conditions: ● as the development of the subdivision proceeded up the Road, you would progressively relinquish the right of carriage; and ● once the development was completed you would have the opportunity of purchasing a block of subdivided land for a reduced cost of $XX,XXX so that you would have “fee simple access” to the Property. After 20 September 1985, you paid Person A the nominal amount to acquire a right of carriage access to the Property. A number of years later, the title of the right of way was issued. A number of years after your separation, a divorce settlement was reached between you and your former spouse under which you acquired their ownership interests in the Property and Land. You were not in a financial position to be able to purchase any land from Person A during the development of their property, with most of the subdivided lots on Person A's property being sold. You entered into a new relationship with Person B. A number of years after your divorce settlement, there were only a limited number of the subdivided lots on Person A's property, with only a small number of those blocks providing access to the Property. Person B purchased a block (Block A) that provided access to the Property for $XX,XXX to facilitate better future access to the Property. You did not relinquish the right of way as this would have compromised your access to the Property if your relationship with Person B ceased. You and Person B discussed plans for a road to continue through Block A into the Property; however these were never undertaken due to your financial circumstances. You have been approached by developers on numerous occasions who had expressed an interest in purchasing and developing some of the Property. You had agreed to the developers corresponding with the relevant bodies in respect of ascertaining the development potential of the Property as follows: ● Person C, who undertook the following activities: ● liaising with the local Council; ● commissioning of traffic impact assessment report and a water sensitive design for a stratum development; and ● organising for the designing a concept to get town water onto the Property. You did not have any input into any of the meetings with the Council, or the commissioning and payment for the reports organised by Person C ● a number of years later, Entity A, who undertook the following activities: ● liaising with the Council; and ● making various requests for relevant costings. You attended some of the meetings with the Council that had been organised by Entity A. No formal agreement/contract had been entered into following the approaches by Person C and Entity A as there was no development potential until water became available to the Property. In the year following the enquiry received from Entity A, you began looking at the possibility of having the properties rezoned under the existing council planning scheme to facilitate the possibility of subdividing the properties at a later stage if circumstances changed to allow the rezoning of the properties to occur. In the following year the construction of a reliable source of water became available near the Property. In the month after the completion of the construction of the water source you engaged the services of Company A. After a number of months Company A prepared a rezoning application (the Rezoning Application) on you and Person B's behalf for the rezoning of the Property and Block A from Rural C to Residential 2 Zone and a boundary adjustment to provide for future vehicle access. Around 12 months later a portion of the Property was rezoned from Rural to Residential 2 as a result of the rezoning application. In the following year Company A prepared an application for planning permit (Planning Permit) for the proposed development of the Property and Block A. Over a period of months the following were prepared by various entities which were submitted to the Council: ● a draft drawing a the proposed subdivision; ● a bushfire report; ● an engineering services report; and ● a traffic impact assessment. A rates notice issued in 20XX outlined that the site value of the whole property is $XXX,XXX. The site value of the portion of the Property being subdivided is $XXX,XXX. The Council approved the Planning Permit subject to specific conditions being met over 12 months after it had been received by the Council. In 20YY, a valuation of the portion of the Property being subdivided was provided by a real estate which outlined that the value of that portion of the Property with the development approval would be between $X.X million and $X.X million. You have estimated the following: ● cost of the subdivision activities will be $X million ● the sale value of each lot will be $XXX,XXX per lot ● you will receive the $XXX,XXX sale price, less real estate agents commission and legal fees. You are opting to sell the portion of the Property by subdividing it due to your retirement as a result of health issues. Also due to financial reasons you now need to sell some of your assets to fund your retirement. You have not attempted to sell any portion of the Property, or the whole of the Property, and wish to continue to reside in the house located on the Property. You will not undertake any hands on or supervisory work as that will be undertaken by the Developer. A real estate agent will be engaged to sell the subdivided lots. You have not made any formal application to borrow any funds to finance the subdivision of the Property at this point and a bank loan will not be required if the Developer funds the subdivision costs. 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. You have not engaged the services of anyone at this point, but will be engaging a developer in the future to undertake the necessary work on a fixed fee. You expect the subdivision activities to commence around mid-20YY and to be completed after a number of months. You are not registered for Goods and Services Tax (GST). The portion of the Property that is not being subdivided is zoned “Environmental Living” by the Council. You do not have any plans to subdivide this portion of the Property and will remain living on the Property. A Draft Development Contract has been prepared which outlines the following: Developer's role ● finance and project manage the subdivision ● progress the planning approval through engineering design, construction and sale of the subdivision ● engaging professionals to undertake subdivision activities ● liaise with service providers ● issue tenders for civil works ● undertake the subdivision to meet the conditions as outlined in the planning permit ● liaise with surveyor ● obtain competitive proposals from at least two Real Estate agents for the marketing and sale of the subdivided lots ● appoint a Real Estate agent to sell the subdivided lots Costs Total costs are unknown at this point. Civil works costs have been estimated to be $XXX,XXX All costs, except for finance, to take the subdivision from planning to construction and sale will be recovered from the sale proceeds at “cost” with no margin to the Developer. Developer's fee The Developer will have the option to either be paid the sum of $XXX,XXX (Goods and Services Tax inclusive), or elect to accept one of the subdivided lots of land as full payment for financing and project managing the subdivision. Assumption(s) For the purposes of this ruling decision the subdivision of the Property will be undertaken in accordance with the: ● the Planning Permit that has been approved by Council; and ● the Draft Development Agreement provided with this ruling.

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

Reasons for decision: Summary: Summary Based on the information provided, you are not carrying on a business of property development. However, any profit from the sale of the subdivided lots will still be accounted for on revenue account as an isolated commercial transaction because you are subdividing the Property for the primary purpose of making a profit on their sale. Detailed reasoning Unless otherwise stated, all legislative references in the following Reasons for Decision are to the Income Tax Assessment Act 1997 . | 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, 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, 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 as a result of the sale of a capital asset. Whether the proceeds are treated as income or capital depends on the situation and circumstances of each particular case. We will consider each of these in relation to your situation as follows: | Detailed Reasoning - Carrying on a business of property development: Section 995 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. Application to your situation Based on the information provided, it is not viewed that you are carrying on a business on buying and selling property, or that this is the commencement of you carrying on a business of buying and selling land. Therefore, any gain made on the disposal of the subdivided lots will not be assessable income under section 6-5 as ordinary income from the carrying on of a business. Therefore, we will consider whether or not the proceeds from the sale of the subdivided lots will be viewed as being received in relation to a profit making undertaking or a mere realisation 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. The ruling outlines at paragraph 6 that whether a profit from an isolated transaction will be ordinary income will depend on the circumstances of the case, however a profit from an isolated transaction will be ordinary income when: a) the intention or purpose of a 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 operation or commercial transaction. 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. 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. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. 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. The direction provided within TR 92/3 and in case law 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. 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. 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 determining whether activities relating to isolated transactions are a profit making undertaking or are the mere 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. Application to your situation In the context of considering the above authorities and factors when determining whether your activities would be viewed as a profit making undertaking, the following general observations of your situation can be made: ● You and your former spouse purchased the Property prior to 20 September 1985 and you built the house on the Property after 20 September 1985, which has been your main residence; ● You acquired your former spouse's ownership interest in the Property after 20 September 19875, and you continued to reside in the house located on the Property until the present time, and intend to continue to reside there after the subdivision of part of the Property; ● You have been approached by developers on numerous occasions who had expressed interest in purchasing and developing some of the Property. However, no formal agreements had been entered into due to the existing lack of access to water on the Property; ● After you had received the expressions of interests, you began to explore the possibility of having the Property rezoned; ● The construction of a nearby water source was completed and the water supply to the area in which the Property is located became more reliable; ● In the following year you engaged the services of Company A who lodged a rezoning application on you and Person B's behalf, to rezone a portion of the Property and a section of Block A from Rural C to Residential 2 Zone, and make a boundary adjustment between to facilitate future provision of vehicular access. The rezoning application was approved by the Council; ● You have not attempted to sell the whole or any portion of the Property on the open market, or the relevant portion of the Property with the approved development agreement; ● The site value of the portion of the Property being subdivided is $XXX,XXX; ● It has been estimated that the market value of the portion of the Property being subdivided if sold with the approved development agreement would be $X,XXX,XXX to $X,XXX,XXX; ● The estimated Gross Revenue from the sale of the subdivided lots will be $X,XXX,XXX, with costs of $X,XXX,XXX; ● The Developer will manage and finance the subdivision of the Property and will receive either $XXX,XXX or a specified number of the subdivided lots at their election as remuneration for their services; ● The Developer will appoint a real estate agent to sell the subdivided lots; ● There has been a change in the purpose for which the Property is being held, being for personal usage to subdividing the Property; ● There has been a change in the nature of the Property with the proposed subdivision transforming the Property from broad acres into small residential lots; ● There is a coherent plan for the subdivision of the Property which is more complex than what would have been involved in the disposal of the Property as broad acres; ● You have approached the subdivision of the properties in a businesslike way and have sought expert advice, and have engaged the services of professionals in relation to the subdivision activities; ● The legal title to the property remains with you and you have the authority to provide the relevant consents and approvals in relation to the subdivision of the properties; and ● 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. 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 of the Property to one of a profit making undertaking. It has been stated in the ruling that you are opting to sell the Property by subdividing it due to your retirement as a result of health issues and also due to financial reasons you now need to sell some of your assets to fund your retirement. The simplest way you could have divested yourself of the Property would have been to dispose of it without seeking any rezoning or subdivision approvals and without actually undertaking the associated works. The acts of seeking approvals and undertaking of the subdivision work must in some way contribute towards a finding that the overall activity constitutes something more than a 'mere realisation' of a capital asset. We accept that there had been no-profit making motive when you had acquired the Property. However, the question before us is whether your intention changed when you committed this one-off undertaking in relation to the subdivision of part of the Property, and sale of the subdivided lots. You have initiated the subdivision of part of the Property and have had engaged the services of Company A to lodge the rezoning application and the Planning Permit. You have also held discussions with other professionals in relation to the subdivision resulting in a Draft Development Contract being prepared. It is estimated that the portion of the Property being subdivided has a site value around $XXX,XXX with the subdivision costs estimated to be around $X,XXX,XXX. Based on those figures, the cost to subdivide this portion of the Property will be many times the value of the Property. You will pay the Developer either $XXX,XXX or will give them a specified number of the subdivided lots in payment for their services. You expect to receive Gross Revenue of $X,XXX,XXX for the sale of the subdivided lots. Therefore, the value of the value of the portion of the Property being entered into the subdivision is a small percentage of the expected Gross Revenue, being less than 10%. Significant value adding to the part of the Property being subdivided has occurred with that portion of the Property having an increased value of $XXX,XXX to $X,XXX,XXX to $X,XXX,XXX with the Development Approval. All costs for the subdivision of the Property to progress the subdivision from planning to the sale of the subdivided lots, except the finance provided by the Developer, will be recovered from the sale proceeds of the subdivided lots. While the Developer is providing the finance to subdivide the Property, you bear the risks in relation to any profit or loss on the sale of the subdivided lots. You have decided to subdivide part of the Property and there has been a change in the purpose for which that portion of the Property is being held. The subdivision will transform that part of the Property from broad acres to small residential allotments. There is a demonstrated intention to profit from the subdivision of the Property and the transaction has been undertaken in a commercial manner. The Property has been used for personal usage, with your main residence located on it. There is a complete lack of nexus of the subdivision of the Property to the previous use of the Property which indicates a clear change of intention to cease one activity and commence a new discrete activity. That is, to change the intention in relation to the Property from being used for personal usage to developing the Property for the purpose of selling the subdivided lots. The change of your plans in relation to the Property are aimed at increasing the number of lots available for sale, with the maximum possible number of subdivided blocks, with the expected increase in the profits from the sale of the lots being more than enough to cover the increased costs due to the subdivision. In your case, you have approached the transaction in a businesslike way. You actively took steps to have the relevant authority rezone the Property a number of years prior to the Planning Permit being lodged with the Council. The services of professionals have been engaged to lodge the relevant applications, undertake surveys and investigations and prepare reports. The inherent nature of the subdivision of the Property is such that it is quite complex given that many preliminary approvals were sought. The process of physically undertaking the subdivision works involves complexities requiring specialist knowledge, the engagement of specialist contractors and the co-ordination of the said parties. The acquisition of the relevant development approvals is not a simple transaction. It involves obtaining information as to the extent that the Property can be developed, having plans drawn up and liaising with council to have the proposal approved. The acts of seeking approvals and undertaking of the subdivision work must in some way contribute towards a finding that the overall activity constitutes something more than a 'mere realisation' of a capital asset. On balance, it would seem that the portion of the Property being subdivided has been ventured into a profit making venture which is on a sufficient scale to characterise it as a commercial or profit-making undertaking. As a consequence, the proceeds from the sale of the subdivided lots will be considered to be ordinary income and therefore assessable under section 6-5. | Detailed Reasoning - Capital gains tax: 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 under section 104-10 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. A capital gain will be made if the cost base of the asset is less than the capital proceeds in accordance with section. Section 118-20 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, for example, as ordinary income under section 6-5. Application to your situation 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 subdivided lots will not be a mere realisation of capital assets. Therefore, as the disposal of the subdivided lots is viewed as an isolated transaction, any profit made on their sale will be included in your assessable income under section 6-5. CGT event A1 will occur on the disposal of each of the subdivided lots. The capital gain for the event is worked out by comparing the cost base of the asset with the capital proceeds for its disposal. If the conditions under Division 115 are met, the capital gain can be reduced by 50% by applying the CGT discount. Any capital gain made on the disposal of the subdivided lots will be reduced to the extent that the profit from the sale of the subdivided lots is included in your assessable income under section 6-5. Note: Any capital gain arising in relation to assets acquired before 20 September 1985 will be disregarded.