Private ruling: Taxation implications on the sale of subdivided land
Published: March 2013
Ruling period: Year ended 30 June 2012 | Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015
Date scheme commenced: 1 July 2011

Ruling: Q1: Will the proceeds of the sale of the subdivided lots, resulting from the sub-division of your property, be assessable as ordinary income? | A1: Yes | Q2: Will the proceeds of the sale of the subdivided lots, resulting from the sub-division of your property, be assessable under the capital gains tax provisions? | A2: No | Q3: Will the subdivided lots be considered active assets for the purposes of accessing the capital gains tax concessions for small business? | A3: Not applicable | Q4: Are you entitled to apply the 50% CGT discount to any capital gain made on disposal of the subdivided lots? | A4: Not applicable

Relevant facts and circumstances: You purchased a property, as joint tenants. The land was purchased for the purpose of building a main residence and commencing a business activity. You later purchased an adjoining property and through a boundary adjustment merged the titles to form a single title. The property, included X hectares used for your private main residence. At the time of the purchase of the second parcel, your intention was to use it in your business. You have been operating a business on this property as a partnership. You had also tried to supplement your income with a separate business activity. Since owning the property it has been used as your main residence and in a business activity. The business activity was unprofitable and you decided to sell the property in order to retire from the activity. You believed that the best way to maximise the market value was to subdivide the land. The business activity ceased in the late 2000's. You engaged a planning consultant and surveyors in the late 2000's to help subdivide the property. A subdivision application was lodged with the local council, and the development application was approved for a residential subdivision. A construction certificate application was lodged with the local council and the certificate was approved. A contract to commence earthworks was then signed with an earthmover. Your loan application for $xxxx was approved for the purposes of completing the subdivision. Prior to this the planning costs were funded with an increase on your overdraft that was used for your business activity a loan facility provided by the bank. The interest on the loan has been capitalised, and not claimed as a business expense. The value of the un-subdivided land (which included the sub-division development approval) was $xxxx. The market value of the subdivided lots (as per the valuation prepared for the bank for mortgage security purposes by a registered valuer) was $xxxx (GST exclusive). This was based on the sale of the lots separately. If sold altogether the value was $xxxx (GST exclusive). One of you began work as a salary and wage earner for another business to earn an income as the business income had been poor. One of you continued to work in this job until a few months after your own business activity ceased. Originally, a real estate agency was engaged to sell some of the lots but these have not yet been sold. The agency agreement subsequently expired and the property was withdrawn from the agent's hands. The lots are being marketed as an estate. One of the lots, which included the family home, has been sold privately. You no longer live on the land. On the sale of the main residence, you paid off most of the outstanding loan. Of the remaining lots, you estimate the market value to be $xxxx based on current sales. You state that it is currently not a good time to sell the lots and you are waiting to see if the prices get better. You consider the land as your source of funding for your retirement and will sell the remaining lots as you need money and the market improves. One of the lots is currently being negotiated for sale to one of your children as a private sale. You state that you pass the small business entity test as the turnover of the business is well under the $2 million threshold. You state that you pass the $6 million maximum net asset value test. There are no other connected entities, apart from your spouse. You do not expect the sale of the lots would make the value of the land exceed this level. You have not been involved in property development nor subdivided land before. The land had always been used in your business activity and as you are registered for GST you have claimed the input tax credits on the development costs in your business activity statements and sold the first lot, which included the family home, under the margin scheme. You have no business plan and have no site office. The subdivision was done in one stage to minimise costs. You state that the development was done to the minimum required by council. You have no experience in subdivision and have engaged a planning consultant, surveyors and engineers to guide you. Where possible you have used your business machinery to save costs for activities such as installing a sediment fence, cleaning, weed control and maintenance. You have also worked on traffic control for three weeks to save costs. The earthmoving contractor constructed the roads and other contractors installed power and telephone lines to the blocks. You are not connected to, or associated with, any of the contractors or professional advisors and consultants.

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

Reasons for decision: Detailed Reasoning - Detailed reasoning: You have subdivided your land, one lot, which included your former family home has been sold, and you intend to sell the remaining lots. Therefore, we will need to determine whether the proceeds to be received on the sale of the subdivided lots: · is assessable ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) as you were carrying on a business of property development · is assessable ordinary income under section 6-5 of the ITAA 1997 as you conducted an isolated commercial transaction with a view to a profit, or · is a realisation of a capital asset and assessable under the capital gains tax provisions of the ITAA 1997. | Detailed Reasoning - Carrying on a business of property development: You have stated that you and your spouse are not, nor have you ever been, in the business of property development and have no expertise relevant to property subdivision activities. Therefore, it is accepted that any proceeds received from the sale of the subdivided land would not be derived in the course of carrying on a business. | Detailed Reasoning - Isolated commercial transaction with a view to profit: Profits arising from an isolated business or commercial transaction will be ordinary income if the taxpayer's purpose or intention in entering into the transaction is to make a profit, even though the transaction may not be part of the ordinary activities of the taxpayer's business ( FC of T v. Myer Emporium Ltd 1987 163 CLR 199; 87 ATC 4363; 18 ATR 693) (Myer Emporium). Taxation Ruling TR 92/3 considers the principles outlined in the Myer Emporium case and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. TR 92/3 defines the term 'isolated transactions' as: · transactions outside the ordinary course of business of a taxpayer carrying on a business, and · transactions entered into by non business taxpayers. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. If a taxpayer makes a profit from a transaction or operation, that profit is income if the transaction or operation is not in the course of the taxpayers business but: · the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain, and · the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction. Paragraph 42 of TR 92/3 acknowledges that in some cases, if a taxpayer acquires an asset with the intention of using it for personal enjoyment but later decides to venture or commit the asset either: a) as the capital of the business; or b) 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 or a business operation or commercial transaction carrying out a profit-making scheme, as the case may be. The profit from the activity is income although the taxpayer did not have the purpose of profit-making at the time of acquiring the asset. Whether an isolated transaction is business or commercial in character will depend on the circumstances of each case. Where a taxpayer's activities have become a separate business operation or commercial transaction, the profits on the sale of subdivided land can be assessed as ordinary income within section 6-5 of the ITAA 1997. TR 92/3 lists the following factors to be considered: a) the nature of the entity undertaking the operation or transaction b) the nature and scale of other activities undertaken by the taxpayer c) the amount of money involved in the operation or transaction and the magnitude of the profit sought or obtained d) the nature, scale and complexity of the operation or transaction e) the manner in which the operation or transaction was entered into or carried out f) the nature of any connection between the relevant taxpayer and any other party to the operation or transaction g) if the transaction involves the acquisition and disposal of property, the nature of that property, and h) the timing of the transaction or the various steps in the transaction. In addition to the above general factors, Miscellaneous Taxation Ruling MT 2006/1 provides a list of specific factors relevant to isolated transactions and sales of real property. If several of the factors are present, it may be an indication that a business or an adventure or concern in the nature of trade is being carried on. These factors are as follows: · 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. No single factor is determinative; rather it will be a combination of factors that will lead to a conclusion as to the character of the activities. In your case, you and your spouse purchased land with the intention of operating a business and building a main residence. Later you acquired a neighbouring block of land and merged the two lots to form a single title. At the time of acquiring the second lot of land, you state your intention was to use it in your business. You conducted a business activity on the land until it ceased during the late 2000's. You state that due to poor income from the business, you also worked as a salary and wage earner for another business. At the time of signing the contract to commence earthworks on the subdivision you were no longer working as a salary and wage earner or conducting a business activity. The value of the un-subdivided land (including development approval) is $xxxx. You borrowed $xxxx for the purpose of completing the subdivision. The market value of the subdivided lots of land prepared by a registered valuer was $xxxx. As the cost of the project is almost half the maximum value of the un-subdivided land, the costs associated with the subdivision are considered significant. In addition, the subdivision and sale will generate approximately $xxxx more in sales proceeds than selling the un-subdivided land. Based on the information provided; there has been change of purpose for which the land is held (that is, the land is no longer used in your business activity and you no longer live on the land). the subdivision is being developed in a businesslike manner as; · you have engaged consultants, surveyors and engineers to guide you through the process · you have engaged contractors to put in the roads, conduct water drainage works and install electricity and telephone services. · the development costs are significant (in comparison to the value of the un-subdivided land) · a substantial loan has been taken out to subdivide the land · there is an estate name for the land · you have claimed input tax credits on the development costs · you are personally involved in the project including · selling/marketing the land yourself · providing some traffic control on the project · using your business equipment to undertake fence installation, cleaning and weed control On balance, it would appear that the subdivision project you have undertaken has the characteristics of a commercial transaction. This is because the amount of capital risked in carrying out the project was significant (in comparison to the value of the land) and your personal involvement in the general development process and marketing of the estate is consistent with what would be expected from a person involved in a commercial enterprise of subdivision or property development. This indicates that the project is in the form of an adventure or concern in the nature of trade and not the mere realisation of a capital asset. Therefore, as the activity was entered into, and any profits made, in the course of carrying out an isolated commercial transaction with a view to a profit, the proceeds will be considered ordinary assessable income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Assessable under the capital gains tax provisions: Section 118-20 of the ITAA 1997 primarily exists to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. In the absence of such a provision, it is conceivable that a receipt properly characterised as ordinary income and which has also been derived as a result of a CGT event could result in the receipt being taxed twice. Therefore, whilst CGT event A1 will happen when you sell your properties, any capital gain will be disregarded to the extent of any amount already included as ordinary assessable income under section 6-5 of the ITAA 1997.