Private ruling: The assessability of proceeds from a land subdivision
Date of advice: 16 March 2016
Published: May 2016
Ruling period: Income year ending 30 June 2016 | Income year ending 30 June 2017; and | Income year ending 30 June 2018.
Date scheme commenced: 1 July 2015.

Ruling: Q1: Will the profit from the sale of subdivided blocks of land be treated as ordinary income under section 6 -5 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of you and your spouse carrying on a business of property development? | A1: No. | Q2: Will the profit from sale of subdivided blocks of land 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: No. | Q3: Will the profit from the sale of subdivided blocks of land be treated as statutory income under the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A3: Yes.

Relevant facts and circumstances: Documentation provided with the private ruling forms part of, and should be read in conjunction with this description. You and your future spouse jointly purchased a property (the property) before 20 September 1985. The land area of the property is over 30 acres. You and your future spouse purchased the property with the intention of it becoming your family home following your marriage, with your wedding occurring a number of months after the property had been purchased. You and your future spouse obtained a loan to finance the purchase of the property. You and your spouse moved into a mobile accommodation located on the property a number of months after your wedding after a structure had been constructed on the property under which the mobile accommodation was positioned. You and your spouse resided in the mobile accommodation for around two years until the loan for the purchase of the property had been paid off. You and your spouse obtained additional finance to purchase a prefabricated home (the house), which was constructed on the property. The construction of the house was completed around three years after the property had been purchased and you and your spouse continue to reside in the house to the present time. The property was used for primary production purposes for around 15 years commencing from the year after the property had been purchased. After that period you and your spouse have not operated a primary production business and are not registered for Goods and Services Tax (GST). The property has been used as a hobby farm. The property was subdivided into two lots over 15 years after the property had been purchased as follows: • Property A, consisting of over 20 acres and • Property B, consisting of less than 10 acres. The property had been subdivided with the specific aim that your relatives, Person A and Person B, would build a residence on Property B in which they would reside (the residence). You and your spouse retained the ownership of Property B and Person A and Person B occupied the residence built on Property B until they passed away over 10 years after the residence had been constructed. The residence located on Property B is currently occupied by your child and their family. Around 20XX, substantial mining activities were undertaken in the immediate area and underneath Property A and Property B. This has led to significant damage to the land and properties resulting in you submitting claims for compensation. As a result of the problems arising from the mining activities below the two properties, and the changes to the Council Zoning which enables landowners to subdivide their land into one acre lots, you and your spouse have decided to sell the properties and move to a new location closer to family members. For the purposes of this ruling you and your spouse will: • Demolish the house located on Property A and subdivide the property into a number of vacant blocks of land; and • the residence located on Property B will not be demolished, but will be sold on a reduced amount of land, with the remaining portion of the land being subdivided as per the subdivision framework agreed at Development Approval. A draft Development Agreement is currently being prepared with a developer (Company A), in relation to the subdivision of the properties and sale of the subdivided lots (the subdivision project). For the purposes of this private ruling: • you and your spouse will contract out the entire subdivision project, being the subdivision and sale of the subdivided lots, to Company A who will fund, manage and sell the subdivision project • Company A will be engaged to undertake the bare minimum as required by Council, with the view to expediting the time frame of getting the lots on the market and to reduce you and your spouse's costs • Under the contract Company A will undertake the following activities in relation to the development project: • carry out feasibility study, seek feedback from financiers and undertake discussion with local valuers • engage development consultants to: Ø survey the land Ø design the lot layout to maximise the number of lots and sale prices Ø undertake flora and fauna investigations Ø achieve mine subsidence clearance Ø produce an on-site effluent report Ø produce a salinity report Ø drainage concept Ø road concept; and Ø statement of environmental effects • submit developmental approval • when required, negotiate with the council and supervise the application through council • achieve development approval and negotiate any adverse conditions imposed • tender for and engage a selling agent • draft sales contracts and generate 88B instrument • engage design consultants to produce construction documents based on development approval conditions • negotiate and guide consultants to develop the best cost benefit design to produce a result consistent with the target buyer group expectations • apply for construction certificate • tender for construction works • review tenders for compliance and competency/capacity to undertake the scope of works • once costs are known, and construction contract signed, set construction finance • commence work in respect of the required: Ø environmental protection survey Ø road works Ø storm water Ø potable water Ø communication infrastructure Ø power; and Ø fencing and landscaping • conduct the final survey, gain subdivision certificates and linen plan; and • effect settlement with contracted purchasers • Company A will receive a fee paid from the proceeds of all of the subdivided lots • The subdivided lots will be advertised, marketed and sold by a real estate agent identified by Company A • You and your spouse will receive an advance loan from Company A (the Developer loan), which is interest free, and which will be repaid out of any proceeds from the sale of the subdivided lots to which you and your spouse are entitled until the loan is repaid in full; and • You and your spouse will receive: • the current value of the properties which will be determined by valuation • Notional interest calculated at a specified percentage per annum • Any Goods and Services Tax (GST) benefit; and • A percentage of the development profit, being any revenue derived from the demolition and removal of existing improvements erected on the properties plus the total sale proceeds of al subdivided lots forming part of the properties less all development costs, sales and marketing costs, holding costs, GST incurred on the sale of the subdivided lots, interest incurred on the Developer loan, the land payment and the landowner's Notional interest. You and your spouse will not have any direct involvement in the subdivision project. You and your spouse have never undertaken any property development. You and your spouse do not have a business plan. You and your spouse will not retain any of the subdivided lots. You and your spouse will reside at another property you own when the subdivision project commences. It is estimated that each subdivided block of land will be sold for over $X00,000, dependant on some variables, such as the size of each subdivided block of land.

Relevant legislative provisions: Income Tax Assessment Act 1997 Section 6-5 | Income Tax Assessment Act 1997 Section 102-20 | Income Tax Assessment Act 1997 Section 104-10 | Income Tax Assessment Act 1997 Section 112-25 | 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: Legislative references referred to herein are from the ITAA 1997 . The proceeds from the sale of the subdivided land are not ordinary income and not assessable under section 6-5. The proceeds represent a mere realisation of a capital asset which will fall for consideration under the capital gains tax provisions in Part 3-1. | 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, sections 10-5 and 102-5, on the basis that a mere realisation of a capital asset has occurred. 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 of the ITAA 1997 states the term 'business' includes any profession, trade, employment, vocation or calling, but does not include occupation as an employee. To determine whether an activity, or series of activities, amounts to a business, the activity needs to be considered against the indicators of a business established by case law. In the High Court of Australia case of Hope v. Bathurst City Council (1980) 144 CLR 1; (1980) 29 ALR 577; (1980) 80 ATC 4386; [1980] HCA 16, a business was described in the following ways: It is the words "carrying on'' which imply the repetition of acts and activities which possess something of a permanent character. …activities engaged in for the purpose of profit on a continuous and repetitive basis. Transactions were entered into on a continuous and repetitive basis for the purpose of making a profit…manifested the essential characteristics required of a business. For a one-off land subdivision to be considered to be of a business or commercial nature, it is usually necessary that a taxpayer has the purpose of profit-making at the time of acquiring the property. The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling TR 97/11 (TR 97/11) which uses the following indicators to determine whether a taxpayer is carrying on a business: • whether the activity has a significant commercial purpose or character; • whether there is repetition and regularity of the activity; • whether the activity is of the same kind and carried on in a similar manner to that of the ordinary trade in that line of business; • whether the activity is planned, organised and carried on in a businesslike manner such that it is directed at 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 a 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. | Detailed Reasoning - Application to your situation: In this case, the property was purchased by you and your spouse before 20 September 1985, and it had been used for it for primary production purposes for over ten years commencing from the year after the property had been purchased. Around the time the primary production activities had ceased the property had been subdivided into Property A and Property B, for the purpose of enabling your relatives to build a residence on Property B. You and your spouse will enter a contract with the Developer, Company A, who will undertake and manage all of the activities in relation to the subdivision of the properties and the sale of the subdivided lots and fund the project. No other property development activity has been undertaken by you and your spouse and there is nothing to suggest that the subdivision of the properties was the beginning of a continuing business of property development. After reviewing the information and documentation provided, it is the Commissioner's view that the activities of you and your spouse are not those of an entity carrying on a business of developing and selling land. The activities undertaken do not display the salient indicator of a business, which are transactions entered into on a continuous and repetitive basis. The subdivision activities are being undertaken by Company A and you and your spouse will not participate in any of the activities involved in the subdivision of Property A and Property B. Therefore, any gain made on the disposal of the subdivided lots will not be assessable as ordinary income from the carrying on of a business. | Detailed Reasoning - Isolated business transactions: Profits from isolated transactions will be assessable as ordinary income where the intention or purpose in entering into the transaction was to make a profit or gain and the transaction was entered into and the profit was made in the course of carrying out a business operation or commercial transaction Taxation Ruling TR 92/3 (TR 92/3) sets out the Commissioner's view of the general principles and factors that have been considered in determining whether an isolated transaction is of a revenue nature. 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. The transaction may take place in the course of carrying on a business even if the transaction is outside the ordinary course of the taxpayer's business. Paragraphs 41 and 42 of the ruling 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. 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. 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. | Detailed Reasoning - Application to your situation: In this case, you and your spouse had not acquired the original property for the purpose of subdivision and resale. Instead, you originally acquired the property for the purpose of residing on the property and farming it. You and your spouse's intention in relation to the properties changed due to the mining activities in the area where the properties are located and the Council rezoning of the area in which Property A and Property B are located. Company A will be contracted to undertake the subdivision activities and they will only undertake the minimum required in accordance with the subdivision approval. Making an overall assessment on the factors set out in TR 92/3, it is the Commissioner's view that the subdivision of the properties and sale of the subdivided lots will be a mere realisation of a capital asset and that you and your spouse are merely realising long-held privately owned properties. Therefore, any profit arising from the sale of the subdivided lots will be accounted for under the capital gains tax provisions in Part 3-1. | 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 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. However, any capital gain or capital loss made on the disposal of a CGT asset will be disregarded if the asset was acquired before 20 September 1985. When a CGT asset (the original asset) is split into 2 or more assets (the new assets), such as when land is subdivided, the subdivision of the land into subdivided blocks is not a CGT event, according to subsection 112-25(2) of the ITAA 1997. Where the original land was acquired before 20 September 1985, each new block retains its pre-CGT status. | Detailed Reasoning - Application to your situation: In this case you and your spouse acquired the original property before 20 September 1985; therefore, the subdivided blocks arising from the original subdivision, and the subdivided blocks arising in relation to the current subdivision project will also be viewed as having been acquired on the date the original property was purchased prior to 20 September 1985. While CGT event A1 will occur when the subdivided lots are sold, as the subdivided lots are viewed as having been acquired before 20 September 1985, pre-CGT, any capital gain or capital loss you and your spouse make on the disposal of each subdivided block will be disregarded for CGT purposes.