Private ruling: CGT - acquisition - disposal - subdivision
Date of advice: 5 February 2016
Published: March 2016
Ruling period: Year ended 30 June 2016 | Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2018 | Year ended 30 June 2019
Date scheme commenced: 1 July 2015

Ruling: Q1: Will the profit arising from the proposed construction and sale of a number of community titled residential apartments be assessable as ordinary income under section 6-5 of the ITAA 1997? | A1: Yes. | Q2: Will you be taken to have acquired the community titles for CGT purposes at the time you acquired the Property, under section 112-25 or section 124-190, and therefore satisfy the 12 month holding rule in section 115-25 for accessing the Division 115 CGT discount? | A2: Yes.

Relevant facts and circumstances: You are 'X' years of age. You are a medical practitioner and practise in your own name. You are registered for GST in connection with the conduct of your practice as a medical practitioner. You own a property (property 'A'), which is your main residence. You have owned this property for a period of time. You acquired an adjacent property, (the property), at a later time. Your CGT cost base for the property is an amount. The area of the property is 'Y' square metres and there is a free standing residence on the land which is in a dilapidated state. The property is structurally unsound and is unsuitable for renovation. The property has been leased pursuant to a residential tenancy to an arm's length tenant since its acquisition through to the present day. Before you acquired the property, it had been designated for use as a specific use. One of the reasons you acquired it was to gain control of the property, to provide a buffer to enhance your private enjoyment of your home. You also intended to renovate the property, sell your existing main residence, and make the property your main residence. The zoning of the property when you acquired it was 'residential' and you considered an extensive renovation, or demolition and replacement with a single level home, would be possible. Early in the 20XX calendar year you decided to explore the possibility of renovating the property and making it your main residence. Around this time, your financial advisor introduced you to a professional, who advised at the time that the building on the property was so structurally unsound that it was not worth renovating. Development of the property therefore always required that the home would be demolished. Around this time, you were made aware that there was a proposed new State Government Development Plan for the property. In 20YY the new Development Plan was approved. The property is now located in a specific zone; amongst other things the development guidelines applicable to the property prescribe that: '* Building height should not exceed a specified metres; * Developments should have a minimum building height of a number of storeys, except where adjacent to a heritage place.' You understand that a specified metre building could be expected to comprise as many as several storeys. In 20ZZ your financial advisor provided a costing prepared by a quantity surveyor, based on a specified storey development. It was anticipated that the property would be community titled and that you would retain an apartment as your main residence. A town planner has advised you that to obtain a Development Approval falling within a specified land use, limited public consultation and no third party appeal rights, any proposed development will require the construction of a building of at least a number of storeys, but not exceeding a specified metres in height, in accordance with the Development Plan described above. This unusual feature of the applicable Development Guidelines is understood to be a consequence of a change in focus of the local Council and State Government in particular, in favour of high rise developments. Further, the property borders local parkland and for the foreseeable future, development would only ever take place on a side of the street. This appears to have encouraged quite specific and unusual Development Guidelines for the precinct. You have progressed a development which involves the construction of a prestige multi storey residential apartment building. You expect your development application will be approved. The expected development cost will be an amount (GST inclusive) which is proposed to be funded with an amount from existing savings and the balance by bank borrowing. You anticipate that the bank will support the development subject to at least a number 'off the plan' sales being achieved. Upon completion of construction your intention is to apply for the issue of a number of community titles in your name. You will retain an apartment for your own use as your main residence. Council approval has not yet been formally requested although the town planner has held informal discussions with the Council and received in principle approval for a multi storey development consistent with the site plan/elevation diagrams. A number of parties have been asked to estimate the likely selling price of the community titles. The average of those estimates suggests total proceeds of sale of an amount. That suggests a profit of an amount. But for your desire to retain an apartment for yourself, you consider it would be an easier commercial proposition to merely obtain a development approval and offer the property for sale to a developer. You have been advised that the likely sale price of the property, carrying Development Approval, would be an amount, and therefore less than the projected amount albeit with a quicker outcome and less risk. You consider the main point of differentiation is your ability to retain a community title as your main residence. You propose to retain the following parties for the purpose of conducting the project: • Architects and Project Manager • Lawyers; tax advice • Town planner; planning advice • A builder, yet to be appointed; and • A real estate agent, yet to be appointed. You conduct your practice as a medical practitioner on a full-time basis and do not anticipate conducting any of the 'hands on' work connected with the conduct of the project. In any event, you have no experience or expertise in property development not having ever conducted any property development project previously. You only have an interest in a holiday house and a residential property which you have leased for a number of years. You propose to commence the project early in the 20VV calendar year. Building work is expected to take a number of months and it is hoped that all apartments would be sold by that time or shortly thereafter. In relation to your plans for the property, you have proceeded to date on the basis that the proceeds of sale of the community titles will be on capital account. Consistent with that view: • You are not registered for GST in connection with the ownership and development of the Property; • You have not claimed, and do not intend to claim, input tax credits for GST charged to you by service providers in connection with the project; • You do not intend to claim a tax deduction for interest expenses in connection with borrowings to fund the project, due to the application of section 51AAAA of the ITAA 1936.

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

Reasons for decision: Summary: The profit from the proposed scheme will be assessable income under section 6-5, being a profit from an isolated commercial transaction entered into with the purpose of making a profit. | Detailed Reasoning - Detailed reasoning: We need to determine whether the profit or gain from the sale of the community titles will be: • assessable ordinary income under section 6-5 of the ITAA 1997 as you will be carrying on a business of property development • assessable as ordinary income under section 6-5 of the ITAA 1997 on the basis that the development will constitute an isolated commercial transaction with a view to a profit, or • a mere realisation of a capital asset and only assessable under the CGT provisions of the ITAA 1997. Carrying on a business of property development Based on the information provided, we do not consider that any proceeds you will receive from the sale of the community titles will be derived in the course of carrying on a business. Profits from an isolated transaction 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 Myer Emporium and provides guidance in determining whether profits from isolated transactions are assessable under section 6-5 of the ITAA 1997 as ordinary income. 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 taxpayer's 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 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 land will 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 contrast, paragraph 36 of TR 92/3 notes that the courts have often said that a profit on the mere realisation of an investment is not income, even if the taxpayer goes about the realisation in an enterprising way. However, if a transaction satisfies the elements set out above it is generally not a mere realisation of an investment. 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. In determining whether activities relating to isolated transactions are an enterprise 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. | Detailed Reasoning - Application to your circumstances: Your activities in constructing the apartment block and selling the apartments will not amount to a business; they will be more in the nature of an isolated, one-off transaction rather than an ongoing series of transactions. However, the activities will be commercial in nature and will therefore constitute a profit making scheme. The transaction will be a commercial transaction. In your case you have approached the transaction in a businesslike way. You have sought expert advice from various professionals. You have estimated that you will make a substantial profit from the transaction. You will be borrowing a significant amount of money, and spending an even larger amount of money, in carrying out the scheme. What you propose doing involves substantially more than merely realising your asset to best advantage. You will be significantly improving the property, increasing its value from around an amount to a significantly higher amount. Addressing in order the points made in your ruling request: 1. You state you have never been a property developer before. However, you are approaching this scheme in a businesslike way and the scheme will constitute a commercial transaction. 2. You did not acquire the property for resale at a profit. However, you are now venturing it into a profit making scheme. This means its value at the time of venturing into the scheme will be its cost for working out the profit. 3. Your purpose in carrying out this scheme is to enable you to retain an apartment as your residence. Notwithstanding this purpose, given the nature and scale of what you will be doing you will be carrying out a profit making scheme (whether you intend it to be or not). 4. You advise you never intended to build a multi-storey apartment block but Council rules now oblige you to. Essentially, the Council rules about new constructions being a minimum number of storeys mean that it is far more likely you will be undertaking a commercial transaction and carrying out a profit making scheme if you want to build yourself a new apartment on the land. However, you have an available alternative, being to sell the land without doing anything to it (which would be a mere realisation). As another alternative, you could sell the land to a developer on the condition that you retain an apartment in the complex. 5. You state you are merely realising your asset to best advantage. In constructing a multi-storey building, you are doing more than merely realising your asset. You are going well beyond a mere realisation and significantly improving the Property. 6. The 50% CGT discount will apply, see the discussion under the heading Question 2 below. 7. GST question, which will be dealt with in a separate ATO ruling. We now address the cases you have cited in support of your contention that the profits from the development will be on capital account: McCorkell v FCT 98 ATC 2199 In that case, the taxpayer was 81 years old and had no family to continue his orchard business. He therefore subdivided his 15 hectare orchard into 37 allotments. The taxpayer did minimal work himself. The AAT held he was not carrying on a business of property development. The AAT said: • 'In addition a growing number of residential properties were abutting his land with growing concerns and complaints about spraying the orchard which was, in some instances, within 15 metres of homes.' [paragraph 4] • 'Mr McCorkell had initially contemplated selling the land as one parcel but had not been able to attract a satisfactory offer.' [paragraph 13] • 'It may well have been that, if Mr McCorkell had chosen an option involving partners or substantial borrowings, there may have been some indicia of business activities. But he did not.' [paragraph 13] This case is distinguishable from yours on the basis that McCorkell: • tried to sell his land but was unable to attract a satisfactory offer, • may have been forced to sell anyway if complaints about spraying had limited his ability to carry on business as an orchardist, and • did not borrow substantial money to implement his plan. Casimaty v FCT 97 ATC 5135 The Federal Court found (at 5138): … at no time did he [Casimaty] do any more in preparing the allotments for sale than was required by the Council apart from slashing and clearing scrub, filling in some creeks and waterholes and pushing up levy banks on creeklines to improve the presentation of certain allotments. His developmental activities never extended to the proposal or creation of public facilities. The case is distinguishable from yours on the basis that Casimaty did minimal work, or as little as possible to ensure sale, whereas in your case you are taking significant additional steps to develop the property to substantially increase its value. Statham & Anor v FCT 89 ATC 4070 The Full Federal Court stated (at 4076) 'the owners were at first content to sell the land as one parcel, but were unable to do so'. In effect, the owners were 'forced' to subdivide as they couldn't sell the land as one parcel. Also, no money was borrowed (although a bank guarantee was provided). Your case is distinguishable from Statham because, while you are, in a sense, 'forced' to build a multi storey apartment block if you want to maximise your return from the property, you would be able to sell the property without any development at all and still make a significant profit. You are also borrowing a significant amount to implement your plan. As Mason J commented in relation to the factual scenario in Whitfords Beach : 'All this amounts to development and improvement of the land to such a marked degree that it is impossible to say that it is mere realization of an asset.' In your case, given you want to substantially enhance the value of your asset; you are essentially required by Council rules to build a multi-storey apartment block. You may be further obliged to build a relatively prestige block, as it might not make any sense to build a basic-quality apartment block in that location. As such, there will be development and improvement of the land to a marked degree such that it would not be possible to characterise what you intend doing as the mere realisation of your asset. Conclusion We consider you will be going above and beyond what is required to merely realise the value of the Property. In particular: • You would be able to sell the property for a substantial profit without developing it. • You will be borrowing a significant amount of money to develop the property. • The development will be a significant enhancement of the property - it will not be a mere realisation of your asset. • You have approached the development in a businesslike way. • You intend to make a significant profit from the transaction. Accordingly, the project will have the characteristics of a commercial transaction. As you will be carrying out an isolated commercial transaction with a view to a profit, the profit made will be ordinary income under section 6-5 of the ITAA 1997. | Detailed Reasoning - Question 2: You make a capital gain or loss as a result of a CGT event happening to a CGT asset. CGT assets include real estate acquired on or after 20 September 1985. You make a capital gain if the capital proceeds from the sale of a CGT asset are greater than the cost base of that asset, for example, if you receive more for an asset than you paid for it. You make a capital loss if the reduced cost base of an asset is greater than the capital proceeds resulting from the sale of the asset, for example, if you receive less for an asset than you paid for it. The inclusion of the profit or gain on the sale of a CGT asset as ordinary income does not mean that a CGT event does not happen in relation to the asset. However, section 118-20 of the ITAA 1997 operates to ensure that amounts which are assessable income outside of the CGT provisions are not also taxed as capital gains. Therefore, while a CGT event will occur when an asset is sold (CGT event A1), any capital gain will be reduced by the amount included as ordinary assessable income under section 6-5 of the ITAA 1997. Where an asset is split into 2 or more assets, and you are the owner of both the original asset and the 'new' asset or assets, section 112-25 provides that the split is not a CGT event and the cost base is apportioned to each 'new' asset in a reasonable way. In broad terms, a capital gain made by an individual is reduced by 50% under Division 115 of the ITAA 1997 if the asset is held for at least 12 months. | Detailed Reasoning - Application to your circumstances: Your capital gain when a community title (that are not your main residence) is sold (CGT event A1) may be greater than the amount of assessable income you are required to include as ordinary assessable income as outlined above in Question 1. You will have an assessable capital gain to the extent of the difference. That is, the profit will be both a capital gain and ordinary income. However, to avoid double taxation, the capital gain will be reduced to the extent the profit is assessable as income under section 6-5 of the ITAA 1997. When the Property is split into a number of 'new' assets (the number of community titles), no CGT event will happen. This means the community titles will be treated for CGT purposes as if they had been acquired when the property was acquired. Accordingly, the 12 month holding rule in section 115-25 of the ITAA 1997 will be satisfied.