Private ruling: Profit derived from subdivision and sale of land - whether mere realisation of capital asset or income according to ordinary concepts
Published: October 2014
Ruling period: Income Year Ending 30 June 2015
Date scheme commenced: 1 July 2014

Ruling: Q1: Will the sale or other disposal by the taxpayer of any part of its land, following the development by a third party give rise to ordinary income for the purposes of section 6-5 of the Income tax Assessment Act 1997 (ITAA 1997)? | A1: No. | Q2: Will any capital gain in respect of the realisation of the land be assessable to the taxpayer under Part 3-1 of the ITAA 1997? | A2: Yes.

Relevant facts and circumstances: The taxpayer is one of a number of owners of separate parcels of land. The separate parcels of land are contiguous and abut another parcel of land owned by Company X. The taxpayer is not related to Company X. The taxpayer has entered into a number of agreements with Company X. Under those agreements: (a) if certain preconditions are satisfied, the taxpayer will have an option that will allow them to require Company X to develop its land for sale as part of an integrated development of the land. (b) if certain preconditions are satisfied, and if the taxpayer does not exercise their options, Company X will have an option that will allow Company X to purchase their land in a single purchase of the relevant parcel; and (c) if certain preconditions are satisfied, and the options are exercised, Company X will develop and sell the land. The taxpayer did not purchase their land with the intention or purpose of profit-making by sale or as part of a profit-making undertaking or scheme. The land was zoned Rural when the taxpayer purchased the land and subdivision was heavily restricted. The land was re-zoned to allow for development at a later date. The taxpayer has neither the resources nor the expertise to undertake a development of their land. It is reliant on Company X's expertise and resources, or ability to procure resources, to have the land developed in a manner that is consistent with how other land in the vicinity will be developed now that it is zoned to allow for development.

Relevant legislative provisions: Income Tax Assessment Act 1997 Part 3-1 | Income Tax Assessment Act 1997 section 6-5

Reasons for decision: Summary: The profit derived from the subdivision and sale of the land is not assessable as ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Section 6-5 of the ITAA 1997 includes in a taxpayers assessable income, where the taxpayer is an Australian resident, all ordinary income derived by the taxpayer both in and out of Australia during an income year. Ordinary income is defined as income according to ordinary concepts. While the Courts have not applied a strict definition of income for each receipt, they have traditionally identified a number of characteristics that provide the basis in determining whether a receipt is income. The main characteristics that have been identified may include the receipt being: • received periodically and regularly • relied upon or expected • earned, and • for the replacement of income. In the present case, the land was zoned Rural when the taxpayer purchased the land and subdivision was heavily restricted. The plan to develop and sell the land arose only when the land was re-zoned to allow for development. The proposed development and sale of the land, though done in a systematic way, does not contain any of the qualities of being income according to ordinary concepts. There is no periodicity, regularity, or recurrence in sale of the land. However, periodicity, recurrence or regularity are not always essential for an amount to be income. In FC of T v. The Myer Emporium Ltd 87 ATC 4363 ( the Myer Emporium case ), the High Court clearly established that the profit arising from an isolated transaction will be of an income nature if the taxpayer's purpose in entering into the transaction was to make a profit. Taxation Ruling TR 92/3 Income tax: whether profits on isolated transactions are income (TR 92/3) sets out the Commissioner's view regarding the profits from isolated transactions and when an isolated transaction amounts to a business operation. Paragraph 35 of TR 92/3 states: 35. A profit from an isolated transaction is …generally assessable income when both the following elements are present: (a) The intention or purpose of the taxpayer in entering into the transaction was to make a profit or gain. (b) The transaction was entered into, and the profit was made, in the course of carrying on a business or in carrying out a business operation or commercial transaction. Paragraph 9 of TR 92/3 states: 9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. In this case, when the land was acquired by the taxpayer, there was no intention or purpose to make profit from the sale of the land. Paragraph 13 of TR 92/3 states: 13. Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following: (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 this case, the nature of the taxpayer cannot be said to be a property developer. They have neither the resources nor the expertise to undertake a development of their land and that is why they have entered into agreements with Company X to carry out all related activities in developing and selling the land. Based on the above analysis, the proposed development and sale of the land cannot be considered as a business operation or commercial transaction and hence the profit from the sale is not income derived from the ordinary course of business. Therefore the profit is not assessable as income under section 6-5 of the ITAA 1997. | Summary: The profit derived from the proposed subdivision and sale of the land is a mere realisation of capital asset and hence assessable under Part 3-1 of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: The question as to whether profit derived from subdivision and sale of land is a mere realisation of a capital asset or assessable as ordinary income is considered in a number of cases. In McClelland v. FC of T 70 ATC 4115, the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only. Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v. Harris (1904) 5 TC 159 at pp 165-166 that: …What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - is the sum of the gain that has been made a mere enhancement of values by realising a security, or is it a gain made in an operation of business in carrying out a scheme of profit-making? In FC of T v. Whitfords Beach Pty Ltd 82 ATC 4031, Gibbs CJ said (at p.4034) that: When the owner of an investment chooses to realize it, and obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk in California Copper …'what is done in not merely a realisation or charge of investment, but an act done in what is truly the carrying on, or carrying out, of a business'. In the Myer Emporium case , it was held (at p 4369) that: It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realization. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction. (Emphasis added). In Case 32/96 , 96 ATC 361, the taxpayer purchased 148 acres of mostly arable farming land in 1950s. Over time, the taxpayer realised part of the land for various purposes including allowing a brickworks operator to extract clay, for the expansion of a school and for the building of a hospital. Following a rezoning of the land, the taxpayer subdivided 38 lots and sold all but one. For one sale, the taxpayer was required to construct an access road which was financed by the subdivision and sale of a further 14 lots. The taxpayer claimed that the sale of the land represented the realisation of a capital asset which had been held over a long period of time and which was originally purchased for farming purposes. The Commissioner claimed that having regard to the financial commitment undertaken as part of the subdivision and the fact that the taxpayer himself undertook the subdivision, the subdivision amounted to the carrying on of a business. The AAT held that: The applicant simply "took the necessary steps to realise the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out" (see the Scottish Australian Mining case at ATC p 140; CLR p. 195). In Scottish Mining Co. Ltd v. FC of T (1949) 9 ATD 135; (1950) 81 CLR 188, the company engaged in coal mining on land it owned since 1863, however it ceased to operate as a mine sometime in 1942. Thereafter it sold off, from time to time, parcels of land formerly used for mining, for residential and other purposes, after having systematically subdivided the land, constructed roads, made sites available for schools and set aside areas for parks, etc. The subdivision was so systematic and scientific that the Commissioner argued that the company had ceased to be a coal miner, and instead was carrying out the profit-making undertaking of selling land. This argument was rejected by the Court, where William J stated (at ATD p 140; CLR p 195): …The facts would, in my opinion, have to be very strong indeed before a Court could be induced to hold that a company which had not purchased or otherwise acquired land for the purpose of profit making by sale was engaged in the business of selling land and not merely realising it when all that the company had done was to take the necessary steps to realise the land to the best advantage, especially land which had been acquired and used for a different purpose which it was no longer businesslike to carry out. His Honour further stated (at ATD p 141; CLR p 197): I am not prepared to hold that the appellant [company] commenced business as a land dealer in 1942 simply because it commenced to realise the Lambton lands. It was not a company which was formed for the purpose of dealing in land and there is to my mind no evidence that it engaged in such a business either before or after 1924. (Emphasis added) In McCorkell v. FC of T 98 ATC 2199; (1998) 39 ATR 1112, the court found that proceeds made by the applicant, who had subdivided land he previously used in his orchard activities and subsequently sold the subdivided lots, did not constitute assessable income as the applicant was not carrying on a business of subdividing and selling land in the relevant years. Relevant factors in the decision included the following: • the taxpayer had no direct involvement in the planning and contracting work for the subdivision or in selling the blocks; • the taxpayer relied on the surveyors and engineers to carry out the work required; • the works carried out in developing the subdivisions were no more than what was necessary to secure the approval of the authorities and enhance the presentation of the individual lots for sale; • the taxpayer had no site office or building on the land and had no direct contact with contractors or potential purchasers; • the taxpayer had no involvement in advertising or promoting the sale of the land; and • the land was sold simply by placing it in the hands of two local real estate agents who recommended and had accepted prices. All negotiations for sale were conducted by the agents. The decision stated that the facts were very similar to those in Statham v. FC of T (1988) 20 ATR 228; 89 ATC 4070. In this case, the court found that the sale by subdivision of farming land constituted a mere realisation of the asset and not proceeds of a business. In reaching the decision the following factors were considered significant by the court: • the owners were at first content to sell the land as one parcel, but were unable to do so; • no moneys were borrowed by them, although a guarantee was provided to the Kingaroy Shire Council by way of a bank guarantee; • only very limited clearing and earthworks were involved; • the owners relied on the Kingaroy Shire Council to carry out road works, kerbing, electricity and sewerage works which were required to be done; • the owners did not erect buildings on the land, not even, for example, a site office; • they had no business organisation, no manager, no office, no secretary, and no letterhead; • the taxpayer maintained his original occupation; • the owners did not advertise the land for sale; • the owners did not engage any contractors, although they did seek some professional advice from an engineer; • the lot was sold by listing it with local real estate agents. Further, in Casimaty v. FC of T 97 ATC 5135, the taxpayer Casimaty acquired the property known as 'Acton View' comprising of 988 acres of land from his father by way of gift in 1955. He conducted dairy and fencing business from that property until faced with financial hardship and deteriorating health, he decide to sell two thirds of the property by eight subdivisions between 1975 and 1995. The proceeds from the sale of the property were considered as derived in the course of carrying on of business of selling land. Ryan J found in the favour of the taxpayer. After considering many reported decisions including Stevenson v. FC of T 91 ATC 4476; (1991) 29 FCR 282 upon which the ATO relied heavily to come to its decision, Ryan J stated (at ATC p 5149; ATR p 373): An examination of the reasoning in Stevenson's Case confirms that whether the subdivisional activity is sufficiently extensive and systematic to amount to the conduct of a business is, as Lockhart J observed in Crow's Case a question of fact. Jenkinson J was not required to resolve that question of fact for himself. He was concerned only to ensure that the Tribunal had not committed any error of law arriving at the conclusion which it did. His Honour did not distil from the authorities a principle of law that a subdivision involving a hundred or more lots, the construction of roads and the reticulation of water to each lot could never amount to a mere realization of a capital asset. Any such principle would run counter to the views expressed by all but one member of the High Court in FC of T v. Williams 72 ATC 4188; (1972) 127 CLR 226 where Gibbs J observed (at ATC 4194-4195; CLR 249): 'An owner of land who holds it until the price of land has risen and then sub-divides and sells it is not thereby engaging in an adventure in the nature of trade, or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of sub-division and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realisation of a capital asset are not income either in accordance with ordinary concepts or within the second limb of sec 26(a), even though the realisation is carried out in an enterprising way to as to secure the best price.' From the above case analysis, it can be said that there is no general indicia as to whether the proceeds for the sale of a land is a mere realisation of capital asset or derived in the course of carrying on a business. However, the following factors seem to be common among the judges in deciding that the profit is a mere realisation of a capital asset, namely: 1. the taxpayer needs to show that there was no intention or purpose to make a profit from the sale of the land when the land was originally acquired 2. the scale of the activity in the sale of the land, while important, is not the sole determining factor, and 3. subdividing and selling the land in the most advantageous and enterprising way does not change the character of the sale from a mere realisation of a capital asset to carrying on a business. In the present case, the following factors are important to take into account in considering whether the proposed development and sale of the land by the taxpayer is a mere realisation of a capital asset or done in the course of carrying on a business: 1. The land was zoned Rural when the taxpayer purchased the land and subdivision was heavily restricted. The taxpayer could therefore have had no expectation of development in the foreseeable future 2. The taxpayer did not purchase their parcel of land with the intention or purpose of profit-making by sale or as part of a profit-making undertaking or scheme; 3. The taxpayer is not related to Company X, and 4. The taxpayer has neither the resources nor the expertise to undertake a development of their land. They are reliant on Company X's expertise and resources, or ability to procure resources, to have the land developed in a manner that is consistent with how other land in the vicinity will be developed now that it is zoned for development. From the above factors, it is considered that the proposed development and sale of the land is a mere realisation of capital asset. There was no intention or purpose on the part of the taxpayer to carry on a business of development and sale of the land. The activities involved in the proposed development and sale of the land show nothing but the most enterprising way that the taxpayer could realise the best outcome from the land now that it is included within the City X's urban growth boundary.