Private ruling: Sale of farmland - revenue or capital
Date of advice: 15 March 2022
Published: May 2022
Ruling period: Financial year ending 30 June 20XX | Financial year ending 30 June 20XX | Financial year ending 30 June 20XX | Financial year ending 30 June 20XX
Date scheme commenced: 1 July 20XX

Ruling: Q1: Will any part of the proceeds or profit made by the Company on the sale of the Subdivided Lots, constitute assessable income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes. | Q2: Will the gain from the sale of the subdivided lots be assessable as the mere realisation of a capital asset? | A2: No.

Relevant facts and circumstances: The farmland (the Land), several XXXX acres, was acquired by the farming family in the middle of the last century. The family has conducted farming operations in the district for generations. The ownership of the Land was transferred to the Company shortly after incorporation approximately XX years ago. The Company was and continues to be controlled by members of the farming family. The Land was used by the Company in operating a dairy farming business for around XX years, when a decision was made to transition the Company's activities to cattle grazing. The Company has operated the beef cattle activity since this time and continue to do so, holding on average, XXX head. Several years ago, the local council released a Local Environmental Plan which introduced changes to zoning within the region. A section of approximately XX acres along the Northern Boundary of the Land was rezoned as residential. Since the rezoning, developers have begun acquiring surrounding properties for the purposes of completing residential subdivisions, consequently, land values have increased. This has also resulted in a substantial increase in the annual council rates for part of the Land that has been rezoned. The Company representatives have received offers for the purchase of sections of the Land. These were below what the controlling minds considered a reasonable price and were not accepted. The Company proposes to develop and subdivide the rezoned section of the Land. The Company has not attempted to sell the Land as a whole, and plan to continue cattle farming operations on the retained Land. Just over XX acres of the Land (including area for a drainage retention basin) will be developed into more than XX lots (the Subdivided Lots), which will be sold. The average allotment size of the proposed subdivided lots is expected to be slightly larger than XXX square metres. The work involved with the development of the land would be limited to the minimum requirements set out by Council in developing the Land. Although the Company has not yet obtained a development approval, the work expected to meet the minimum council requirements will include roads, street lighting, footpaths, landscaping, drainage, water and sewage. The development costs are expected to be more than $X million. The development of the Land is expected to take three to four years. Although the Company has some cash reserves, however it will need to seek finance to cover the development costs If it proceeds with the development in one stage. The Company will engage the required engineers and planners to prepare the applications to be lodged with council. The Company will engage a professional developer to undertake the proposed development on a quoted fee for service arrangement. The sale of the Subdivided Lots will be arranged through local real estate agents. The Company expects sale proceeds to be in the order of more than $X million. The controllers of the Company are considering undertaking the proposed subdivision development rather than, for instance, selling the Land to a developer to complete the development. This will allow for better control over the final shape and nature of the development, considered important because the Company will continue to own the remainder of the Land. Completing the development itself will also maximise the Company's financial return from the development.

Relevant legislative provisions: Income Tax Assessment Act Section 6-5 | Income Tax Assessment Act Section 70-10 | Income Tax Assessment Act Paragraph 118-25(1)(b) | Income Tax Assessment Act Part 3-1 and Part 3-3

Reasons for decision: Summary: When considered against the relevant case law indicia, the Company's activities in developing, subdividing and selling the land, are considered to be those of a land development business. The Subdivided Lots will be sold as the Company's trading stock. Sale proceeds will be assessable income under section 6-5 of the ITAA 1997 and are not considered to be the 'mere realisation' of the Land. | Detailed Reasoning - Detailed reasoning: In generally, there are three ways by which the proceeds or gains from dealing in land gain be treated for income tax purposes: • Sale proceeds are treated as ordinary income under section 6-5 of the ITAA 1997 where the land is held as trading stock and sold as part of carrying on a business. • Profits are treated as ordinary income under section 6-5, where land is not trading stock and is sold as part of an isolated commercial transaction entered into with a profit-making intention. • Gains are treated as statutory income under the CGT provisions in Part 3-1 and Part 3-3, where the land is neither trading stock nor the subject of an isolated profit-making scheme or undertaking and the proceeds of sale are the mere realisation of a capital asset. Subsection 6-5(2) of the ITAA 1997 provides that the assessable income of an Australian resident includes ordinary income derived directly or indirectly from all sources, whether in or out of Australia, during the income year 'Ordinary income' is defined in section 6-5 of the ITAA 1997 to mean 'income according to ordinary concepts'. In general, a receipt will constitute income according to ordinary concepts if it is a receipt arising out of a taxpayer's employment or in the normal scope of a taxpayer's business. In limited circumstances, gains not within the ordinary scope of a taxpayer's business may form part of ordinary income Where the sale of property is held to be a 'mere realisation' the sale is on capital account to which the CGT rules in Part 3-1 and Part 3-3 will generally apply. These proceeds are not ordinary income | Detailed Reasoning - Carrying on a business of property development: Under section 70-10 of the ITAA 1997, 'trading stock' is defined as including 'anything produced, manufactured or acquired that is held for purposes of manufacture, sale or exchange in the ordinary course of a business'. In order to determine if the Subdivided Lots will constitute 'trading stock', it is necessary to firstly consider whether the Company activities will carry out the business of property development and sale. Whether a business is being carried on is a question of fact and degree. The courts have considered this issue extensively over the years developing a series of indicia that are applied to determine the matter on the particular facts. In McClelland v FC of T 70 ATC 4115 , the Privy Council held that the question to be answered was whether the facts revealed a mere realisation of capital, albeit in an enterprising way, or whether they justify a finding that the taxpayer went beyond this and engaged in a trade of dealing in the asset, albeit on one occasion only. Lord Justice Clark, in distinguishing between proceeds that is mere realisation of capital and ordinary income, stated in California Copper Syndicate v Harris (1904) 5 TC 159 at pp 165-166 that: ...What is the line which separates the two classes of cases may be difficult to define, and each case must be considered according to its facts; the question to be determined being - Is the sum of gain that has been made a mere enhancement of value by realising a security, or is it a gain made in an operation of business in carrying out a scheme for profit-making? Lord Justice Clerk's approach was adopted by the High Court of Australia in Whitfords Beach Pty Ltd v Commissioner of Taxation ( Whitfords Beach ) 82 ATC 4031, with Gibbs CJ stating at page 4034: When the owner of an investment chooses to realise it, obtains a greater price for it than he paid to acquire it, the enhanced price will not be income within ordinary usages and concepts, unless, to use the words of the Lord Justice Clerk..." what is done is not merely a realisation or change of investment, but an act done in what is truly the carrying on, or carrying out, of a business ". A leading authority on 'mere realisation' of a capital asset is the case of Scottish Australian Mining Co. Limited v FCT (1950) 81 CLR 188 ( Scottish Australian Mining ) . In this case, the taxpayer was formed for the purpose of mining coal and purchased land in 1863 to carry on that business. After mining operations ceased in 1924, the taxpayer subdivided the land; built roads and a railway station; made sites available for schools, churches and parks; and sold the subdivided parcels at a considerable profit. The court held that the profits should not be included in assessable income as the taxpayer had not acquired the land for the purpose of profit-making by sale, nor was it engaged in the business of selling land. It had merely taken 'the necessary steps to realise the land to the best advantage'. The decision in ( Whitfords Beach ) has narrowed the scope of the 'mere realisation' doctrine. In this case, Justice Mason stated at paragraph 385 that: However, apart altogether from this factor, the facts previously mentioned show that there was involved more than mere realization of an asset. Deane J. was right in pointing to the circumstance that the asset was divided and improved in the course of a business of dividing and improving the asset. In this respect I do not agree with the proposition which appears to be founded on remarks in some of the judgments that sale of land which has been subdivided is necessarily no more than the realization of an asset merely because it is an enterprising way of realizing the asset to the best advantage. That may be so in the case where an area of land is merely divided into several allotments. But it is not so in a case such as the present where the planned subdivision takes place on a massive scale, involving the laying out and construction of roads, the provision of parklands, services and other improvements. 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. We need to bear in mind that the subdivision of broad acres into marketable residential allotments involves much more in the way of planning, development and improvement than was formerly the case. The Federal Court has since endeavoured to reconcile those decisions. For example, in Stevenson v FCT 91 ATC 4476 ( Stevenson ), the taxpayer owned and worked on a farm of approximately 446 acres that had been in his family since 1904. The taxpayer sold 26 acres to a statutory body in 1965, and later sold a further 360 acres to a company for farming. Of the remaining 90 acres, the taxpayer decided to keep a few acres for himself and his family and the rest would be subdivided, which was conditional on the provision of water and sewerage reticulation. After attempts to sell the whole area marked for subdivision (as an en globo development site) failed, the taxpayer decided to subdivide the land into more than 180 blocks. Jenkinson J upheld the Tribunal's finding that the taxpayer's activities went beyond what could be accepted as the mere realisation of a capital asset. The Tribunal had particular regard to the degree of the taxpayer's personal involvement in the planning, in the negotiations with the shire council, in obtaining finance, in employing contractors, in the marketing of the blocks and in their actual sale. Jenkinson J accepted the Tribunal's observations and said: It is, I think, difficult to discriminate between mere realisation and the conduct of a business by reference directly to the magnitude of the physical activity or the physical effect of the activity, although Mason J does seem to regard the degree of development and improvement of the land as critical. The magnitude of a substantial subdivisional enterprise does, however, commonly entail such a degree of systematic organisation, planning, management and repetition of purposeful profit-making activity that the carrying on of a business may be more clearly discerned than in a case 'where an area of land is merely divided into several allotments.' It was the magnitude of the enterprise that led Jenkinson J to find that the taxpayer had commenced carrying on a business. Jenkinson J distinguished the situation in that case from one where 'land is merely divided into several allotments'. In Casimaty v FCT 97 ATC 5135 ( Casimaty ), the Federal Court consider facts that were quite similar to those in Stevenson's case, but Ryan J reached a different conclusion. That case involved land previously used by the taxpayer in a dairy farming business that was no longer financially viable. The Taxpayer had originally acquired the land from his father and, at that time, he had only contemplated farming the land. It became necessary for the taxpayer to sell portions of the land to alleviate financial hardship. As there was no ready market for large farming lots, the taxpayer sold off approximately two-thirds of the property as subdivided lots. Ryan J referred to the earlier judgment of the court in Stevenson and said that Jenkinson J did not distil from the authorities a principle of law that a subdivision involving a hundred or more lots, the construction of roads and the reticulation of water to each lot could never amount to a mere realisation of a capital asset. Ryan J observed that any such principle would run counter to the views expressed by all but one of the members of the High Court in FCT v Williams (1972) 127 CLR 226, where Gibbs J had observed: An owner of land who holds it until the price of land has risen and then sub-divides and sells it is not thereby engaging in an adventure in the nature of trade or carrying out a profit-making scheme. The situation is not altered by the fact that the landowner seeks and acts upon the advice of an expert as to the best method of sub-division and sale or by the fact that he carries out work such as grading, levelling, road-building and the provision of reticulation for water and power to enable the land to be sold to its best advantage. The proceeds resulting from the mere realisation of a capital asset are not income either in accordance with ordinary concepts or within the second limb of sec. 26(a), even though the realisation is carried out in an enterprising way so as to secure the best price. Ryan J later said: Nor did the taxpayer undertake any works on, or development of, the land beyond what was necessary to secure the approval by the municipal authorities of the successive plans of subdivision and enhance the presentation of individual allotments for sale as vacant blocks. Had he constructed dwelling houses, internal fencing or other improvements, it would have been easier to impute to him an intention to carry on a business of land development and improvement. Similarly, had he set up his own sales organisation or advertised or conducted sales himself instead of entrusting those activities entirely to his traditional agents, Roberts Ltd, the inference would have been more strongly available that he had gone into the business of selling farmlets or rural residential allotments. That inference was drawn by the Tribunal in Stevenson's case where the taxpayer, at least from stage 2 of his development, personally dealt with prospective purchasers as well as 'multi-listing' the blocks with a variety of agents. The principles were also applied in Statham & Anor v. Federal Commissioner of Taxation (1988) 89 ATC 4070 ( Statham ), where it was held that the sale of a rural property that had been subject to four stages of subdivision was a mere realisation of the property. In their joint judgment, Woodward, Lockhart and Hartigan JJ provided at page 4075 that: It is well established by the reported cases, including those mentioned above, that the mere realisation of an asset at a profit does not necessarily render the profit taxable. The profit must arise from the carrying on of a business or a profit-making undertaking or scheme. The mere magnitude of the realisation does not convert it into such a business, undertaking or scheme; but the scale of the realisation activities is a relevant matter to be taken into account in determining the nature of the realisation, i.e. in determining whether the facts establish a mere realisation of a capital asset or a business or profit-making undertaking or scheme. Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11) discusses the Commissioner's view on whether a taxpayer is carrying on a business. Ultimately, the question of whether the activities of a taxpayer amount to a business is decided on the facts of each case. The Commissioner considers that the following matters (listed at paragraph 13 of TR 97/11) are relevant in determining whether a taxpayer is conducting a business of property development and sale. • Whether the activity has a significant commercial purpose or character. • Whether the taxpayer has more than just an intention to engage in business. • Whether the taxpayer has a purpose of profit as well as a prospect of profit from the activity. • 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, and • The size, scale and permanency of the 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 profile. | Detailed Reasoning - Significant commercial purpose or character: The 'significant commercial purpose or character' indicator is closely linked to the other indicators and is a generalisation drawn from the interaction of the other indicators. It is particularly linked to the size and scale of activity, the repetition and regularity of activity and the profit indicators. In this case, the Company needs to obtain a development approval before the subdivision and sale of the Land can proceed. The development application will consider the planning requirements and set out the detailed engineering and layout of the proposed development. The Company will need to engage professionals to carry out this work on their behalf. After obtaining approval for the development, the Company will engage an experienced contractor to undertake the physical development works on a fee for service basis. The works required to prepare the XXX square metre Subdivided Lots will be significant, with costs expected to be more than $X million. Prior to committing to the development, the Company will undertake a detailed cost analysis and negotiate costs with the development contractor prior to entering the development agreement. It is expected that the Company will need to borrow money allow the development to be undertaken in one stage. The Company will engage real estate agents to market and sell the Subdivided Lots on their behalf. Employing professional agents will ensure that their sale proceeds from the development are maximised. It is expected that the sale proceeds will be more than $X million. Although the Company may not undertake the engineering, planning, surveying, development, marketing and sales activities themselves, they will engage professional third parties to do this as agents on their behalf. This will allow the Company to benefit from the skills and knowledge of these organisations, whilst maintaining a high level of decision making and control of the overall activity. This is similar to the situation in Stevenson where the taxpayer engaged surveyors, planners and development contractors to carry out work in his behalf. You have stated that the Company wishes to be involved in the subdivision activities allowing for better control over the final shape and nature of the development. You considered this important given the Company will retain the adjoining land. Although it is accepted that the part of the reason for the Companies involvement in the development is to retain control over its final shape and nature, this should not prevent a conclusion that it's activities may amount to the carrying on a business. A high level of control by owners over property developments on their land, leads more readily to the conclusion that the landowner is engaging in a property development business. The Commissioner considers that the land subdivision and sale activities proposed in this case, have a significant commercial purpose and character. | Detailed Reasoning - Intention to engage in business: In Inglis v. FC of T 80 ATC 4001 at 4004-4005; (1979) 10 ATR 493 at 496-497, Brennan J stated that " the carrying on of a business is not a matter merely of intention. It is a matter of activity...., the extent of activity determines whether a business is being carried on. That is a question of fact and degree. " This activity is particularly related to whether the activity is preparatory or preliminary to the ultimate activity. The Company in this case is already engaging in business being its beef cattle farming enterprise. Taxation Ruling TR 2019/ 1 Income tax: when does a company carry on a business? (TR 2019/1), provides that presumption at paragraph 19, that certain companies carry on a business. This does not however have application to the conduct of a specific business (paragraph 15 - 17 of TR 2019/1) and does not provide authority in this case. Whether a Company receipt is income or capital in nature, must be considered on the facts of each case (paragraph 61 of TR 2019/1). The Company has not previously engaged in any land subdivision and sale activities. It is therefore less likely that preliminary planning, engineering, development approval and the assessing of financial viability would be considered to be part of the business activity. It is anticipated that the Company will continue to consider its options for dealing with the rezoned section of the Land. A decision may still be taken not to proceed with the subdivision and sale of the land. The Company may elect instead to sell the section of land with a development approval in place or continue to farm the land. The signing of the development agreement is considered to be to be an important milestone where the activities undertaken by the Company will transition from being preparatory and preliminary in nature. In making this decision the Company commits to the extensive work required to develop, subdivide and sell the lots. Its intention in holding this subject area of the Land will change from one of farming to that of development. This change of intention will provide a positive indicator that the Company has commenced carrying on the business of land subdivision and sale. | Detailed Reasoning - The intention to make a profit or a genuine belief that profit will be made: Strong evidence of an intention to make a profit occurs when you have conducted research into your proposed activity, consulted experts or received advice on the running of the activity and the profitability of it, before setting up the business. You have stated in the application, that the Company will undertake the development itself in order to maximise its financial returns in addition to maintaining control over the final shape and nature of the development. Although the Company has received offers for the Land, it has not attempted to subdivide and sell off the portion of land that has been rezoned. When considered objectively, this provides indication that they are prepared to take commercial risk in order to maximise their profits from the development. This provides an important distinction from Statham and Casimaty , where the taxpayers options to sell the land in larger parcels or as a whole was limited. In this case the Company will undertake a decision-making process and assessing profitability before making the final decision to proceed. It will determine its expenditure will be through consultations with engineers, planners and development subcontractors. It will predict its sale proceeds through consultation with real estate professionals. Costs will be analysed against proceeds to project the expected profits. On the basis of information provided with the application, the Company will likely achieve a profit in excess of $X million from undertaking the activity. The intention to profit and likelihood of profit in this case are both considered positive indicators that proceeding with the proposed development will result in the Company carrying on a business of land development and sale. | Detailed Reasoning - Repetition and regularity in the activity: The Company has not previously undertaking land development and sale previously. However, the proposed activity involves a significant amount of work expected to be carried out over three to four years. This is not considered a significantly strong indicator in this case. As previously discussed, it is likely to have some bearing over when the business activity is considered to have commenced in this case. | Detailed Reasoning - Activity of the same kind and carried on in a similar way to that of the ordinary trade: An activity is more likely to be a business when it is carried on in a manner similar to that of other participants in the same industry. In this case although the Company may not directly carry out the activities, the Commissioner considers that the engaged professionals and subcontractors will act as agents of the Company. Their conduct will be the conduct of the Company. The proposed contractor engagement arrangements being similar to those undertaken in Stevenson , where the taxpayer engaged the services of surveyors/planners and a contractor for the development work. The engagement of professionals and experienced subcontractors allows the Company to utilise skills and expertise that it does not itself hold. This being common business practice and will help ensure the work is carried out in a professional way. The development activities in this case will be of the same kind and carried out in a similar way to the that of the ordinary trade. This provides a positive indicator that the Company will carry on a business of land development and sale should it proceed with the development. | Detailed Reasoning - Activity organised in a businesslike manner: A business is characteristically carried on in a systematic and organised manner rather than on an ad hoc basis. An activity should generally conform with ordinary commercial principles to amount to the carrying on of a business. A high level of planning and organisation will be required to undertake the land subdivision and sale in this case. This is considered a strong indicator of a business of property development and sale. | Detailed Reasoning - The size and scale of the activity: The larger the scale of the activity the more likely it will be that the taxpayer is carrying on a business. The size or scale of the activity is not a determinative test, and a person may carry on a business in a small way. You have contended that the density of the development provided by the allotment size (500 square metres) is merely reflective of council guidelines and other residential developments in the area. Although this may be the case, the high density requires substantially more development works than was the case in either Statham or Casimaty . In Statham , only limited clearing and earthworks were involved in preparing the rural allotments for sale and these activities were undertaken by the local council. Similarly, in Casimaty , minimal works were required to meet the council requirements of the farmlets and rural residential allotments. Here extensive works over three to four years at a cost of more than $X million will be undertaken. These are expected to include roads, street lighting, footpaths, landscaping, drainage, water and sewage. The size, scale and costs of the activities in this case are considered a positive indicator that the Company will engage in the business of property development and sale should they proceed with the development. | Detailed Reasoning - The activity better described as a hobby, a form of recreation or a sporting activity: The Commissioner considers that the proposed activities are not a hobby or a form of recreation. This indicator is not relevant. | Detailed Reasoning - Conclusion: The Company will undertake the development activity in a carefully planned, structured and organised way. There will be a significant amount of activity undertaken by the Company and its agents to prepare the Subdivided Land for sale. The development costs to prepare the high density lots for sale is significant, financing is likely to be required to fund these costs. By undertaking the development, the Company will expose itself to much higher commercial risk compared to other options to realise the subject land. In reward for undertaking the subdivision and sale, the Company is expected to make an estimated profit of $X million. It is the Commissioner's view that the level of activities to undertake the proposed development will go beyond merely realising the area of Land subject to rezoning in an enterprising way. Sufficient indicia are present to conclude that the Company's activities in undertaking the proposed development will amount to carrying on a business of land subdivision and sale. Subdivided Lots will be sold as trading stock of the Company's business of land subdivision and sale, with proceeds assessable income under section 6-5 of the ITAA 1997. Any capital gain or loss made on the sale of the subdivided Lots by the Company will be disregarded under paragraph 118-25(1)(b) of the ITAA 1997 on the basis that the Lots will be trading stock of the Company.