Private ruling: Capital Gains Tax - Cost Base
Date of advice: 4 November 2016
Published: March 2017
Ruling period: Year ended 30 June 2017 | Year ended 30 June 2018 | Year ended 30 June 2019 | Year ended 30 June 2020 | Year ended 30 June 2021
Date scheme commenced: 1 January 2007

Ruling: Q1: Will any profit from an unplanned sale of the land be subject to the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997? | A1: Yes. | Q2: Can an amount paid for labour to independent contractors to operate the machinery whilst carrying out the earthworks be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997? | A2: Yes. | Q3: Can the value of any of your or your sibling's labour be included in the cost base of the land for any capital improvements or repairs that they may personally carry out? | A3: No. | Q4: Can an amount paid for fuel to operate the machinery whilst carrying out the earthworks be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997? | A4: Yes | Q5: Can repair and maintenance costs incurred in operating the machinery whilst carrying out the earthworks be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997? | A5: Yes. | Q6: Can you include a value for depreciation of the machinery in the cost base of the land? | A6: No. | Q7: Can an amount paid for supplies be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997? | A7: Yes. | Q8: Can an amount paid for the supply and erection of fencing on the land be included in the cost base under subsection 110-25(5) of the ITAA 1997? | A8: Yes.

Relevant facts and circumstances: You and your siblings inherited land from your parents as tenants in common sometime after 20 September 1985. The land is contained on one title and is a number of hectares. There was a house on the land and it was rented, this house has been demolished. The property is now vacant land. The land was re-zoned from Rural to Urban a few years ago. You and your siblings have incurred costs of a few hundred thousand to complete the re-zoning. The costs were incurred for various studies and reports necessary for the re-zoning and the current proposal to rent the site. The Rural zoning classification meant that any sub-division into larger lots was not allowed. The land had to remain as is and used for rural purposes. You understood the Urban zoning to mean that the land could be sub-divided. However a recent application by a neighbouring land owner was refused. The cost of owning the land in the 20XX/YY year has been significant due to land tax and shire rates mainly. The market value of the land is unknown due to the uncertainty about the zoning. There have been no recent valuations. The land has not been listed for sale since it was inherited; however it was listed on for expression of interest only. No interest was received. There have been no offers to purchase the property. You and your siblings will develop the land for rental as vacant land to compensate for the increase in Land tax and Shire Rates associated with the re-zoning. The land is not being sold and is not being prepared for sale. The works that will be undertaken on the land is to prepare it for rental as vacant land. You and your siblings will seek a Z year lease agreement for the land. This will give you a means to derive income until there is a decision on the ultimate use for the land. Your land is ex grazing land and requires substantial earthworks to remove vegetation, level and fill, provide vegetation and security fencing. You have engaged an engineer to provide drainage design and provide a site plan. The works that you propose require approval by Council. The proposal also requires the land to be re-zoned from Urban to Light Industrial. The works and re-zoning are currently being reconsidered by Council after initially being rejected and a subsequent mediation. You have further engaged professionals to represent you. This course of action is evidence of your intention to develop the site as suitable for rental as vacant land and secure a long term lease for its use in this way. You have further chosen this development for the land because, apart from there being a demand for it, it also requires the minimum amount of development. You and your siblings will borrow money to fund or part fund the development subject to a final rental agreement. You and your siblings have a separate bank account in all names for the purpose of carrying out the proposed works. There is no sales agreement in place for the sale of the land. Any eventual sale should it occur will be in its current state or as developed for rental as vacant land. Your intention is to develop the land for rental, however if a buyer came forward with an offer tomorrow and this offer is within the price that you wish to receive for the land, you would immediately accept the offer and sell the land in full. If the land is sold you and your siblings will split the proceeds equally regardless of what any individual does in developing the land. The land is being developed to gain rental income, at some time in the future should the lessor require other structures then they may be erected as required. None are planned at this time. A factory or warehouse is not being built on the land. There is no plan to sell the land, the earthworks will only commence once you have the necessary Council/Shire approval of the use; and have secured a rental agreement. The land will not be sub-divided. You and your siblings as co-owners of the land will not purchase the other owner/owners share or sell your share to an independent third party. You estimate the follow costs categories for the earthworks. Total work time 60 days (3 months) ● Machinery ● Fuel Cost ● Labour cost ● Repairs and Maintenance ● Depreciation ● Materials For the purposes of this private binding ruling you and your siblings will purchase the machinery to carry out the earthworks. The labour costs for operating the machinery may include a notional figure for the value of your or your sibling's time in operating this equipment, as well as amounts paid to independent contractors. The fencing cost may include a notional component for your or your sibling's labour in erecting it as well as an amount paid to an independent contractor. The repairs and maintenance cost is based on the cost of a potential break down whilst carrying out the earthworks and any need for a machine to be greased up. This cost may include a notional value for your or your sibling's labour to carry out the servicing of this machinery. The fuel will be purchased by you and your siblings using funds from the joint bank account. The materials will be purchased from an independent third party. You and your siblings will incur this cost.

Relevant legislative provisions: Income Tax Assessment Act 1997 , Section 43-20 | Income Tax Assessment Act 1997 , Section 43-70 | Income Tax Assessment Act 1997 , Section 110-25 | Income Tax Assessment Act 1997, Sub-section 110-25(3) | Income Tax Assessment Act 1997 , Sub-section 110-25(4) | Income Tax Assessment Act 1997 , Section 108-55 | Income Tax Assessment Act 1997 , Section 108-60 | Income Tax Assessment Act 1997 , Section 108-70(1)

Reasons for decision: Summary: Any profit from an unplanned sale of the land will be subject to the capital gains tax provisions in Parts 3-1 and 3-3 of the ITAA 1997. | Detailed Reasoning - Detailed Reasoning: There are three possibilities as to how any profit from the sale of the land could be treated. ● assessable as ordinary income under section 6-5 of the ITAA 1997 as carrying on a business of property development ● assessable as ordinary income under section 6-5 of the ITAA 1997 as conducting an isolated commercial transaction with a view to a profit, or ● as a realisation of a capital asset and assessable under the CGT provisions of the ITAA 1997. In determining how the profit from the sale of the land will be treated we have considered all of the possibilities: Carrying on a business of property development Based on the information provided, we do not consider that any profit received from the sale of the land would be derived in the course of carrying on a business. Profits from an isolated transaction Profits arising from an isolated business or commercial transactions 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. Having regards to your circumstances and the factors outlined in TR 92/3, we do not consider that any profit from an unplanned sale of the land will be assessable under section 6-5 of the ITAA 1997. We consider that the disposal of the land will be a mere realisation of a capital asset. This is because you have said: ● that the land is being developed for long term lease as vacant land; ● that the earthworks will only commence once you have the necessary Council/Shire approval and have secured a lease agreement, preferably for X years; and ● you have taken action to have the land re-zoned from Urban to Light Industrial so that the development of the land as suitable for lease can happen. | Summary: An amount paid for labour to independent contractors to operate the machinery whilst carrying out the earthworks can be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997. An amount paid for fuel to operate the machinery whilst carrying out the earthworks be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997. Repair and maintenance costs incurred in operating the machinery whilst carrying out the earthworks can be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997 An amount paid for materials can be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997. An amount paid for the supply and erection of fencing can be included in the cost base of the land under subsection 110-25(5) of the ITAA 1997. | Detailed Reasoning - Detailed reasoning: Fourth element of the cost base - subsection 110-25(5) of the ITAA 1997 Subsection 110-25(5) of the ITAA 1997 provides that the fourth element of a CGT asset's cost base is capital expenditure incurred: (a) the purpose or the expected effect of which is to increase or preserve the asset's value; or (b) that relates to installing or moving the asset. In this case, the CGT asset is the vacant land. As noted above, for expenditure to be included in the fourth element of the cost base of an asset under subsection 110-25(5) of the ITAA 1997, it must be incurred to enhance the value of the asset. In order to carry out the earthworks (improvements) to the land you and your siblings will incur costs on the purchase of materials, repair and maintenance, and associated labour costs. Note: In relation to the repair and maintenance costs that can be included in the cost base, it must be the actual cost paid. You cannot calculate this cost by reference to a typical average or a notional daily cost for this kind of machinery. The costs must be incurred and only those repair and maintenance costs incurred during the actual work time period of 60 days. Any repairs or maintenance carried out on the machinery either before or after the earthworks have started or ceased cannot be included. Again any notional value for either your or your sibling's labour to carry out repairs or maintenance cannot be included. In summary, the expected effect of the earthworks is to increase or at the very least preserve the land's value. Therefore, the costs incurred on the purchase of those items to carry out the earthworks can be included in the fourth element of the cost base under section 110-25(5) of the ITAA 1997. | Detailed Reasoning - Question 3: The value of you and/or your sibling's labour cannot be included in the cost base of the land for any capital improvements or repairs that you personally carry out. No value (notional value) of your own labour can be included in the cost base for any of the work that you carry out to either repair or maintain or improve the land. The value of your own labour is specifically excluded. This ATO view exists in CGT Determination Number 60 (TD 60) Capital Gains: can the value of a taxpayer's labour be included in the cost base of an asset constructed by the taxpayer? | Summary: You cannot include depreciation for the machinery in the cost base of the land. | Detailed Reasoning - Detailed reasoning: You cannot include a value for depreciation in the cost base of the land for two reasons: 1. You are calculating depreciation for the machinery and the machinery is a separate CGT asset to the land. The machinery does not form part of the land nor is it being sold with the land; and 2. Depreciation is an accounting concept that represents the write off of a capital asset (in this case the machinery) over its effective life. The machinery is considered to be depreciating assets. There is no outlay expenditure, no actual expense is incurred. As no expense is incurred, from a capital gains tax perspective depreciation cannot be considered to form part of the cost base of a CGT asset. You are not incurring capital expenditure in respect of the decline in value of the machinery.