Private ruling: Income tax – capital v revenue
Date of advice: 26 June 2018
Published: September 2018
Ruling period: 1/7/201X to 30/06/201Y
Date scheme commenced: 1/7/201X

Ruling: Q1: Will the proposed subdivision activities being undertaken by the Taxpayers be a mere realisation of a capital asset? | A1: No.

Relevant facts and circumstances: Acquisition and use of Site A The Taxpayer purchased vacant land in the early 1980s. The land was approximately xx acres in size. During the 1980s the Taxpayer built a house on the land and has lived there ever since. The house and land is known as ‘Site A’. At the same time, a stable complex and a number of horse facilities were constructed. The remaining land was divided into a number of paddocks in which a trough system was installed. The use of the land for horse activities was for pleasure – grazing and training horses to ride for pleasure and in equestrian competitions. The Taxpayer was married in the late 1980s, and a year later transferred the Site A property into joint names with their spouse, utilising the stamp duty exemption for married couples. At all times, the house has been the primary residence of the Taxpayer and their spouse. Over the years, the number of horses being grazed at Site A has declined as the Taxpayer and their spouse competed less often. As a result the land requires regular slashing to reduce the fire risk which is both time-consuming and expensive. Site B development In the 1970s, along with the Taxpayer’s two siblings, the Taxpayer inherited approximately xx acres of land adjacent to Site A. This land was acquired by the Taxpayer’s parent in the 1960s and was used for residential purposes and farming – which involved the grazing of sheep and cattle. These farming activities continued on the land from the 1960s until the mid-2000s. The Taxpayer and one of their siblings acquired the ownership interest owned by their other sibling in the 2000s as the other sibling did not want to be involved on an ongoing basis. The Taxpayer is currently a 50% owner. Due to the effects of drought, the land becoming land-locked, the construction of a sewer and the issue of fire hazard to adjoining properties, it became difficult to maintain farming activity on the land. Accordingly, the Taxpayer and their sibling decided to embark on a subdivision of the land. Development consent for the subdivision was granted in the 2000s. The development is known as Site B and is being undertaken by the Taxpayer and their sibling (Site B partnership). Relevant specialists are engaged as necessary. The Site B subdivision is being funded by bank debt. The income from the Site B subdivision is returned on revenue account, with the land treated as trading stock. Infrastructure and Rezoning Changes In the early 2000s, council identified the area in which Site A and B are located as potentially available for future development in order to meet the growing population requirements of the city. The council released a Contributions Plan (CP) which outlined the infrastructure improvements proposed for the area and how these would be funded. Sewer The development consent for the Site B subdivision required that a sewer main must be provided through the subdivision and extended to provide a service to adjoining upstream properties, including Site A. This has been constructed. Proposed subdivision of Site A The land at Site A is no longer required by the Taxpayer and their spouse for the horse activities previously conducted on the land. In addition, planning and infrastructure conditions have aligned to facilitate the subdivision of land at Site A. It was stated in the private ruling application that the construction of the sewer and a road through the southern portion of Site A land gives road frontage and sewer access to the Site A land, facilitating the possibility of a subdivision of Site A. The Taxpayer and their spouse will continue to live at Site A. The Taxpayer and their spouse are proposing a staged subdivision of Site A: ● Stage 1 – subdivision of 4 lots of land adjoining the existing road frontage. These lots will have underground services (electricity, water, sewerage, gas, NBN). ● Stage 2 – subdivision of 5 or 6 lots. Access to these lots will require construction of a road from an existing road as well as underground services. ● Stage 3 – subdivision of 2 lots closest to the existing residence. Total consideration received for all lots is expected to be approximately $C million. Costs of the subdivision are expected to be approximately $D million. Costs will include items such as agent’s commission, construction costs of the road, council contributions, and infrastructure connection fees. The Taxpayer and their spouse will outsource these activities to relevant specialists via a Project Manager/Engineer. The costs will be funded by existing funds of the Taxpayer and their spouse. There will be no building on the subdivided land with the only work undertaken being that which is necessary to secure approval by the council for the subdivision. A Development Application has been lodged with Council. Relevant clauses from Statement of Environmental Effects – Site A. Utility Services – Electrical, Telecommunications and Gas …As part of the design and construction of site B Estate, an allowance was made for the electrical, telecommunications and gas servicing of these additional lots…. Sewerage and Water Supply Water Supply …The watermain is located on the southern side of Street B constructed as part of the Site B Estate. This included two conduit crossing of Street B near the common boundaries of lots A and B for the 20mm road crossings to serve these four lots in Stage 1 to avoid the need for either opening or under boring the road….

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 995-1

Reasons for decision: Summary: Section 6-5 of the ITAA 1997 includes in your assessable income, where you are an Australian resident, all ordinary income which you derive during an income year. The proceeds from the sale of land will constitute ordinary income where they are the proceeds of “what is truly an act done in carrying on the business”: California Copper Syndicate v Harris (1904) 5 TC 159 at pp.165-166. | Detailed Reasoning - Carrying on a business of property development: Subsection 995-1(1) of the ITAA 1997 defines 'business' to include '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 to be determined on a case by case basis. Paragraph 13 of TR 97/11: Income Tax: Am I carrying on a business of primary production (TR 97/11) states that the courts have held that the following indicators are relevant to whether or not a person is carrying on a business (although TR 97/11 specifically deals with carrying on a primary production business, the principles discussed in that Ruling can apply to any business): a) whether the activity has a significant commercial purpose or character b) whether the taxpayer has more than a mere intention to engage in business c) whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity d) whether there is regularity and repetition of the activity e) 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 f) whether the activity is planned, organised and carried on in a businesslike manner such that it is described as making a profit g) the size, scale and permanency of the activity, and h) whether the activity is better described as a hobby, a form of recreation or a sporting activity | Detailed Reasoning - Application to your circumstances: Through their 50% ownership in the Site B development, the Taxpayer is considered to be carrying on a business of property development. The following facts have been taken into account in determining this: ● The Site B development is on a large scale and involves a significant amount of work and expense. ● The Taxpayer is returning income from the Site B subdivision on revenue account. ● The Site B land is being treated as trading stock ● The Taxpayer is managing the Site B subdivision themselves, along with their sibling. ● To carry out the Site B subdivision, the Taxpayer and their sibling have engaged a number of professionals and specialists. ● The Site B subdivision has been funded with bank debt, with the Taxpayer and their sibling assuming the financial risk of the development. The Commissioner considers that the proposed subdivision of Site A will be an activity that is part of the Taxpayer’s property development business. In the facts and evidence provided to date, it has not been demonstrated that there is a separation between the Site A subdivision and the Site B subdivision. The following factors have been taken into consideration in contributing to the Commissioner’s perception that the Site A subdivision and the Site B subdivision are interrelated: Acquisition of Site A and Site B The Site B land was acquired by the Taxpayer’s parent in the 1960s for residential purposes and farming. This continued after the Taxpayer inherited the land from their parent. There was a change of intention for the Site B land when it commenced being held as trading stock in the Taxpayer’s property development business of subdividing Site B. The Site A land was acquired by the Taxpayer in the 1980s for residential purposes and horse activities. Therefore, both properties were not acquired with a profit making intention; however the intention changed to a profit making intention at a point after acquisition. In this sense, both properties and subdivisions are identical. Road The Contributions Plan included a proposed road through the precinct. A conceptual location for the road was presented in the draft CP. Part of this road was constructed through the southern portion of the Site A land. The Taxpayer and their spouse annexed this portion of their Site A land and transferred it to the partnership of the Taxpayer and their sibling (Site B partnership) for the purpose of building this road. No consideration was paid for this land and no documents or correspondence between the Taxpayer and their spouse as owners of Site A, the taxpayer and their sibling as owners of site B (Site B partnership) or Council, regarding annexing of the Site A land has been provided. The Commissioner notes that no capital gain has been declared by the Taxpayer’s spouse on the annexing of the portion of the Site A land for the purpose of building this road. This tax treatment is consistent with the Taxpayer holding the sale of the land on revenue account. The cost of construction of the road was funded by the Site B partnership and credits were received by the Site B partnership on development contributions. The Commissioner therefore considers that this piece of land that was annexed and given up for the Site B subdivision was done to further the Taxpayer’s property development activities. Abeles case Justice O’Loughlin in the case of Abeles and Anor v. Federal Commissioner of Taxation (1991) 91 ATC 4756 stated that: Through Mr. Markham, the brothers went beyond a mere simple subdivision and sale of their 10 acres; they entered into an arrangement that was in the nature of a joint venture, sharing costs and expenses rateably; they even participated in variations to the boundaries of their land in order to present, and participate in, the best plan of subdivision…. Although the size of a project is not a conclusive factor, it is one of numerous matters that are to be weighed in the balance. In this case, the readiness of the brothers to involve themselves with the other owners was more consistent with a business enterprise than a private realisation. The taxpayers, through their agent, Mr. Markham, chose to embark upon a business-like and efficient program of subdivision. It is accepted that the reason for acquisition of the property in the Abeles case was different to both Site A and Site B. However, the court considered the relationship that the Abeles property had to the neighbouring developments in helping to ascertain whether the sale was part of a business of subdividing property or whether it was a mere realisation. It is considered that this aspect of Abeles case is similar to the Site A subdivision, as the variation of the boundaries of Site A was not done to realise an asset (noting no consideration was received by the Site A land owners) rather the annexing of the land was done as part of the Taxpayer’s property development business. Through annexing and giving up a part of their property to the neighbouring development for the purposes of the construction of a road that will in turn benefit their own Site A subdivision, the Taxpayer and their spouse are seen to be acting in a businesslike manner, with the Site A subdivision merely a further activity in the Taxpayer’s property development business. Statement of Environmental Effects – Site A Sections of the Statement of Environmental Effects prepared as part of the Site A Development Application refer to instances where the future subdivision of Site A was contemplated as part of the Site B subdivision. A section states that ‘as part of the design and construction of the Site B Estate, an allowance was made for the electrical, telecommunications and gas servicing of these additional lots.’ Another section states that ‘the watermain….constructed as part of the Site B Estate...included two conduit crossings of Street B near the common boundaries of lots A and B….to serve these four lots in Stage 1 to avoid the need for either opening or under boring the road’ This further adds to the perception that the Site B subdivision and Site A subdivision are interrelated. Method of carrying out subdivision – the Taxpayer running subdivision, engaging experts Although the Site B subdivision is on a larger scale than the Site A subdivision, the manner in which both subdivisions will be carried out is identical, as is highlighted by the following facts: ● The Taxpayer will be managing both subdivisions, as opposed to engaging a property developer. While they will not be carrying out the subdivision activities of Site A themselves, they will be managing and co-ordinating the relevant specialists via a Project Manager/Engineer, and therefore will maintain a significant degree of control over the subdivision. ● To carry out the Site B subdivision, the Taxpayer and their sibling engaged a number of professionals and specialists including Engineer E A to design the subdivision. Engineer E will also be engaged to design the Site A subdivision. ● Both Site B and Site A were acquired for purposes other than property development, subdivision and sale. Now both these lands have experienced a change in purpose, where the purposes of both properties now encompass property development, subdivision and sale. ● Both the Site B and Site A development will be undertaken through a partnership encompassing the owners of the land. ● Both Site B and Site A fall within the Council and the Contribution Plan. Therefore the construction requirements will be similar (if not identical) for both Site B and Site A. ● Both the Site B and Site A developments propose to construct allotments in similar locations (the locations abut one another) and of similar size. Therefore not only will the construction requirements be similar (if not identical), but the target market will identical too. i.e. the Taxpayer will be developing an identical product to sell to an identical client base. In addition to the fact that it’s almost impossible to distinguish the two projects from one another (other than fact the Site A land is smaller than the Site B land) the Commissioner considers that certain aspects of the two subdivisions, in particular the manner in which the properties were treated by the parties, suggests the overall arrangement to subdivide these two properties were at the end of the day connected and done for the advancement of the Taxpayer’s property development business. In light of this the Commissioner can see no justifiable reason why the Site A subdivision should be treated any differently to the Site B subdivision. | Detailed Reasoning - Mere Realisation: The doctrine of ‘mere realisation’ was developed in the Full High Court case of Scottish Australian Mining Co Ltd v Federal Commissioner of Taxation (1950) 81 CLR 188 ( Scottish Australian Mining ), and has been relied upon by numerous cases post its decision such as in FC of T v NF Williams to hold the sale of land which has been subdivided is necessarily no more than the mere realisation of capital asset, with any improvements in such as subdivision as being merely an enterprising way to realise an asset to its best advantage. For many years it was felt that the doctrine of ‘mere realisation’ was applied so broadly that it was thought that only in exceptional circumstances would an isolated transaction fall within the ordinary concepts of income. However this all changed in 1982 when the landmark Full High Court case of FC of T v Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031( Whitfords Beach ) was decided. The decision in Whitfords Beach has significantly narrowed the scope of the ‘mere realisation’ doctrine developed by Scottish Australian Mining, which so many of the proceeding cases relied upon. The case highlights that while ‘mere realisation’ may still be possible where blocks are merely subdivided to several blocks with minimal activity, however where the size and scale of the activity reaches such a level (such as constructing roads, the provision of parklands, services and other), this all amounts to a development and improvement of the land to such marked degree that it’s no longer possible to say it’s a mere realisation of an asset. The case of Whitfords Beach also highlights the requirements of modern day residential subdivision that involves much more by way development and improvement of land than was formerly the case, making it far more difficult for modern day residential subdivisions to satisfy the ‘mere realisation’ doctrine. The Taxpayer has already entered into the business of property development through their involvement in the Site B subdivision. The activities required for the Site B subdivision are of a significant size and scale that they would not be considered mere realisation, which has been accepted and demonstrated by the fact that the Taxpayer has treated the Site B subdivision as a property development business. As the Commissioner has demonstrated above, the Site A development is virtually identical to the Site B development, other than the fact that the Site A title covers a smaller area of land then the Site B title. When this is considered together with the fact that the Site A land has been utilised in connection with the Site B development and hence the Taxpayer’s property development business, it would be inconceivable for the Commissioner to treat the sale of the subdivided Site A lots differently to the site B subdivided lots. The sales would just be a part of the Taxpayer’s property development business (which is done in partnership with the respective landholders), and therefore cannot be considered as the mere realisation of a capital asset. Casimaty Case The Taxpayer has noted the Full Federal Court case Casimaty v FC of T (1997) 97 ATC 5135; 37 ATR 358 (Casimaty) where the Court ruled that sales from subdivision occurred as part of the mere realisation of a capital asset. However, in this case Mr Casimaty was not in the business of property development while the taxpayer is. Furthermore in the case of Casimaty, the taxpayer was subdividing the property in an un-coordinated piece meal manner, as the need arose, to prop up an ailing farming business, while in the Taxpayer’s case they are undertaking a co-ordinated approach to undertake a planned subdivision of the Site A land. In Casimaty each piecemeal subdivision had minimal works, with some of the lots (farm type lots as opposed to a residential subdivision your proposing) being larger than the whole of the Site B land. Therefore considering these facts the Commissioner considers the case of Casimaty to be quite distinct from the Taxpayer and their spouse’s. Case 3/2016 The Taxpayer referred to the case of Case 3/2016 [2016] AATA 348 , however the Commissioner notes that this is an Administrative Appeals Tribunal case, therefore the components of the decision in this case cannot be used as precedent for other cases. The decisions of a Tribunal do not create legal precedent like a court case would, but rather merely represent a decision on the facts of the particular case in question. The Commissioner also notes that the decision in Case 3/2016 [2016] AATA 348 involved the fundamental question of whether the property in that case was purchased with the initial intention of profit making from its sale, which can be contrasted to the Taxpayer’s case, where the Commissioner has accepted that the property was not acquired for the initial purpose of profit making from its sale. The Taxpayer’s case is a case concerning the change of intent of the property holding, which is totally different to the situation faced by the taxpayer in Case 3/2016. Therefore it would be inappropriate to even use Case 3/2016 [2016] AATA 348 , as being a case to highlight a decision of the Tribunal on factually similar facts, when the question to be answered by the Tribunal in that case is vastly different to the questions needed to be answered in the Taxpayer’s case. Statham Case. The case Statham & Anor v. Federal Commissioner of Taxation 89 ATC 4070, (Statham) is often sighted in cases considering the mere realisation principles. However in addition to the fact that in Statham’s case the taxpayer was not involved in a property development business, the other distinguishing feature of Statham’s case, which separates it from the Taxpayer’s case, was the fact that in Statham case the taxpayer was ‘...at first content to sell the land as one parcel, but were unable to do so’ . Therefore the taxpayer in Statham’s case was compelled to subdivide the property to realise its value. This can be distinguished from the Taxpayer’s case, as they have made no attempt to sell the land as one parcel. It was the Taxpayer’s choice to subdivide the land in line with the property development business activities that they were undertaking with the Site B development. The Taxpayer and their spouse weren’t compelled into undertaking this activity, merely to put them in a position to sell the property. Further Issues : The Taxpayer contends that their spouse has no interest in the Site B subdivision and so the relationship of the Site A subdivision to the Site B subdivision is not relevant to ascertaining their treatment of the Site A subdivision. As highlighted by Western Gold Mines N.L. v. Commissioner of Taxation (W.A.) (1938) 59 CLR 729, the Commissioner is required “... to make both a wide survey and an exact scrutiny of the taxpayer's activities . This principle was further extended by such cases as GRE insurance Limited and Unitraders Investments Pty Ltd v FCT (1992) 92 ATC 4089 and Grollo Nominees Pty Ltd v FC of T 97 ATC 4585 which specifically demonstrates that the Commissioner not only can, but he must consider the relationship that the entity/taxpayer in question has with the wider economic/family group, when determining these type of cases. Now the fact is, the Taxpayers are spouses. While the Taxpayer’s spouse may not be personally involved, in all correspondence and dealings in respect of the Site A property, the Taxpayer has been representing their spouse, with their spouse in many respects acquiescing their decision making to the Taxpayer, in particular when it came to decisions relating to the Site B development of the Site A land. This is even supported by the ruling application, with the ruling application made as a single application, and the Taxpayer being the sole taxpayer representative in all dealings with this office. As joint owners of the Site A land, the Taxpayer’s spouse gifted the portion of the land used for the road to the Site B partnership in the same manner as the Taxpayer. It’s also noted that the Taxpayer’s spouse did not declare a capital gain on the disposal of the annexed portion of land, which is consistent with treating the development and sale of the subdivided land as assessable income. Based on this, it is clear that the Taxpayer’s spouse is not acting separately from the Taxpayer, but is acting according to the Taxpayer’s directions or wishes, and in concert with the Taxpayer. The Commissioner also notes that the land is held jointly by the Taxpayer and their spouse and that upon the disposal of the subdivided lots, the Taxpayer and their spouse will be in receipt of the income jointly. This would at a very minimum constitute a tax law partnership (refer to definition of partnership in section 995 of the ITAA 1997). Now where partners venture land into a business of property development it would be inconceivable for the Commissioner to treat one partners’ share of the sale from that business as ordinary income under section 6-5 of the ITAA 1997, and the other partners share as capital gain. Therefore, the Commissioner considers the proposed Site A subdivision as one business activity and not two discrete undertakings by the Taxpayer and their spouse. On this basis, the tax treatment on the sale of the properties should be the same for both the Taxpayer and their spouse.