Private ruling: Subdivision of land
Published: July 2012
Ruling period: Year ended 30 June 2012 | Year ended 30 June 2013
Date scheme commenced: 1 July 2011

Ruling: Questions and answers: | 1. Will the property become trading stock under Division 70 of the Income Tax Assessment Act 1997 (ITAA 1997) as a result of the proposed land development? | No | 2. If the answer to question 1 is yes, at what time will the property become trading stock? | Not applicable | 3. If the answer to question 1 is yes, when the deemed disposal takes place under section 70-30 of the ITAA 1997, will the property meet the active asset test in section 152-35 of the ITAA 1997? | Not applicable | 4. If the land is not trading stock under Division 70 of the ITAA 1997, will the individual subdivided lots created out of the previously vacant area of the land satisfy the active asset test in section 152-35 of the ITAA 1997 when they are sold? | No

Relevant facts and circumstances: You and your spouse (you) are the joint owners of a property (the property) which you acquired after 20 September 1985. You use the property for both domestic and business purposes. You acquired the property with the intention of holding it for long term purposes. You did not have an intention of realising the property in the short or long term profit making undertaking or scheme as a business activity, or for profitable resale. Domestic use of property Your main residence (which includes a dwelling, front and back yard, and swimming pool) is located on the front portion of the property and comprises 20% of the total property. The rear of the property, which accounts for approximately 60% of the total property, is vacant and is only occasionally used private recreational purposes. Business use of property You are the directors and employees of a company (the company) which runs a business. The total area of the property used for business purposes is almost 20% of the property. The business has been based on the property since the year of purchase. Work is also done at various job sites for customers on a contract/needs basis. The business requires the storage of hazardous equipment on the property. For this reason, special storage facilities are needed which are located on the property. No part of the property has ever been rented out, nor is the property maintained for the purpose of deriving rental income. Proposed development You wish to develop the property by subdividing it into separate residential lots. The total area of the property to be used for this purpose will be about 2/3 of the property. A part of the rear area will also be developed to provide community facilities and public open space. Upon completion of that development the relevant part of the rear area will be compulsorily acquired by the Council. This portion of the land is approximately 40% of the total property. You are not currently registered for GST. If the proposed plan goes ahead, you plan to register for GST. You are not a property developer. You do not have any formal qualifications, previous experience or knowledge of property development. You have provided a plan which illustrates the proposed development. You will have some say in how decisions are made and you will be entitled to a share of the sale proceeds as per the Land development agreement, The development works will be undertaken by a developer, a company which has been established for the purposes of undertaking this development. The developer is owned and controlled by a relative. The relative is a registered domestic builder with several years experience in building and development work. He specialises in house and land packages and small to medium residential development projects. You have stated the relative is appropriately qualified and holds a Certificate IV in Residential Building. You will engage the relative who is a property developer who will be responsible for: · preparation of a business plan and cash flow for the project · obtaining the necessary funds for the project · any interest of finance costs of the owners in connection with the maintenance of the property · payment of all outgoings in connection with the maintenance and ownership of the property · establishment and maintenance of insurance policies · contracting with all consultants, including town planners, valuers, lawyers, architects and designers · obtaining of all licences, authorities and permits · contracting with construction contractors including quantity surveyors, engineers, environmental scientists, tradesmen and landscape designers · promotion and arrangement of all sales and appointment of sales agents including real estate agents and solicitors · management of the day-to day operations of the project in accordance with the business plan. You are currently in the process of obtaining planning permits for the development and have engaged the developer for this purpose. You and the developer have signed a services agreement to govern your relationship during the planning permit process. Under that agreement, the developer will be remunerated for this work, but it will not have any financial stake in the development unless the development formally proceeds. You consider the development to be one-off in nature. If the planning permits are issued by the appropriate authority and you decide to proceed with the development, you propose to engage the developer. At this time a Land Development Agreement (LDA) will be executed by you and the developer. You have included a copy of the proposed draft LDA.

Relevant legislative provisions: Income Tax Assessment Act 1997 Subsection 6-5. | Income Tax Assessment Act 1997 Subsection 6-10 | Income Tax Assessment Act 1997 Subsection 15-15. | Income Tax Assessment Act 1997 Subsection 70-30. | Income Tax Assessment Act 1997 Subsection 152-15. | Income Tax Assessment Act 1997 Subsection 152-35. | Income Tax Assessment Act 1997 Subsection 152-40.

Reasons for decision: Summary: Will the property become trading stock? | Detailed Reasoning - Taxation treatment of land subdivisions: There are three ways profits from a land subdivision can be treated for taxation purposes: As ordinary income under section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997), on revenue account, as a result of carrying on a business of property development, involving the sale of land as trading stock. As ordinary income under section 6-5 of the ITAA 1997, 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. As statutory income under the capital gains tax (CGT) legislation (sections 10-5 and 102-5 of the ITAA 1997) on the basis that a mere realisation of a capital asset has occurred. | Detailed Reasoning - Mere realisation of a capital asset: The mere realisation of a capital asset is not income. However, if the capital asset is ventured into a business operation or commercial transaction with a profit making intention, the profit may be assessable. The case Californian Copper Syndicate v. Harris (inspector or Taxes) (1904) 5 TC 195 is a leading authority for the principle that a mere realisation of an asset does not give rise to assessable income. The line between the mere realisation of an asset and activities that, in the course of realisation, given rise to assessable income is narrow. For example, in Scottish Australian Mining Co Ltd v. FC of T (1950) 81 CLR 188, the taxpayer acquired 1771 acres of land between 1863 and 1865 which it used for the purpose of coal mining until the coal was exhausted in 1924. It then commenced to progressively subdivide and sell the land. The taxpayer constructed roads, built a railway station, gave land to institutions, such as schools and churches, and set aside land for parks. Williams J considered that the mere extensiveness of the organisation set up to realise the land did not cause the realisation to become a business. In contrast with this decision is Whitfords Beach Pty Ltd v. FC of T (1982) 82 ATC 4031. In this case, the original company was formed for the purpose of enabling its shareholders who were proprietors of fishing shacks, access to the beachfront. There was no profit-making intention at the time of formation of the company or acquisition of the land. Some years later, the original shareholders sold their shares in the company to three development companies. The new owners intended to develop the land and upon acquiring it, altered the articles of association of the company and commenced to develop and sell the land. The Commissioner sought to assess the profits made under subsection 25(1) of the Income Tax Assessment Act 1936 (ITAA 1936), the predecessor to section 6-5 of the ITAA 1997. The taxpayer argued that what has been done was a mere realisation and sought to rely on the Scottish Australian Mining Case . The High Court decided that the fact that a change in ownership had occurred and the new owner was in the business of land development meant that the gains realised were not gains from the mere realisation of an asset but ordinary income. It is necessary to determine if the profit you will make on the disposal of the subdivided land will arise in the course of carrying on a business. | Detailed Reasoning - Carrying on a business of property development: The Commissioner's view on whether a taxpayer is carrying on a business is found in Taxation Ruling 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. In line with Taxation Ruling TR 97/11, we agree that the land development will be a significant commercial activity with more than X residential lots due to be undertaken. We acknowledge your goal is to make a profit from the sale of lots. There will be repetition and regularity of activities even if the development is a 'one-off' venture. The activities will be carried out in a systematic and businesslike manner in line with a business plan. However, it is the developer who has the expertise and who will be responsible for the development. It is the developer who will be engaged in carrying on a business in land development. The circumstances in Whitfords Beach Case and Scottish Australian Mining Case are different to the circumstances in your case. The realisation of the property by you cannot be described as the carrying on of a business. The development activities that will be carried out by the land developer involve the subdivision of land acquired on date X. Whilst we acknowledge that you will have some say in how decisions are made (for example, relating to the sale of the subdivided lots, including the sale price and terms), and you will be entitled to a share of the sale proceeds as per the Land development agreement, your involvement in the actual land development will be minimal. You will engage a property developer to carry out and manage the entire project. You do not have any expertise in land development. Your skills are in undertaking other business activities. In your situation, the Commissioner does not consider you and your spouse will be carrying on a business of property development as: · You and your spouse are not land developers · You both do not have any formal qualifications, previous experience or knowledge of property development · You consider the development to be 'one-off' in nature You both will not be directly involved with the day to day activities of the development You will engage a property developer who will be responsible for: · preparation of a business plan and cash flow for the project · obtaining the necessary funds for the project · any interest of finance costs of the owners in connection with the maintenance of the property · payment of all outgoings in connection with the maintenance and ownership of the property · establishment and maintenance of insurance policies · contracting with all consultants, including town planners, valuers, lawyers, architects and designers · obtaining of all licences, authorities and permits · contracting with construction contractors including quantity surveyors, engineers, environmental scientists, tradesmen and landscape designers · promotion and arrangement of all sales and appointment of sales agents including real estate agents and solicitors · management of the day-to day operations of the project in accordance with the business plan. There have been several cases such as McCorkell v FC of T (1998) 98 ATC 2199; (1998) 39 ATR 1112, Statham v FC of T (1988) 20 ATR 228; 89 ATC 4070 and Casimaty v FC of T 151 ALR 242; (1997) 97 ATC 5135; (1997) 37 ATR 358 that specifically dealt with property development. The courts in these cases have been reluctant to find that there is a business unless the taxpayer is involved directly with the day to day activities of the development. In your case it is clear the developer will be responsible for the day to day activities of the development. In the Land development agreement it is stated the developer's obligations include the management of day to day operations of the entire project. In summary, you will not be in the business of land development as you will not be involved in the day to day management of the subdivision project. Consequently the subdivided blocks will not constitute trading stock. Taking into account the circumstances of your case, the sale of the subdivided lots will be considered to be the mere realisation of an asset and therefore any profits made will not form part of assessable income under section 6-5 of the ITAA 1997. However, while you will not be carrying on a business of property development, the proceeds from the sale may still be assessable as ordinary income, if those proceeds are considered to be from an isolated business transaction. | Detailed Reasoning - Isolated business transactions: The Commissioners view on whether profits from isolated transactions are assessable as ordinary income is found in Taxation Ruling TR 92/3. The term 'isolated transactions' refers to: · those transactions outside the ordinary course of business of a taxpayer carrying on a business; and · those transactions entered into by non-business taxpayers. TR 92/3 states profits on an isolated transaction will be ordinary income when: · the intention or purpose of a taxpayer 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 on a business operation or commercial transaction. 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. In the case Federal Commissioner of Taxation v. The Myer Emporium Ltd (1987) 163 CLR 199; 87 ATC 4363; 18 ATR 693, the Full High Court said the following about the nature of profits from isolated transactions and the purpose of profit-making at the time of acquisition: It is one thing if the decision to sell an asset is taken after its acquisition, there having been no intention or purpose at the time of acquisition of acquiring for the purpose of profit-making by sale. Then, if the asset be not a revenue asset on other grounds, the profit made is capital because it proceeds from a mere realisation. But it is quite another thing if the decision to sell is taken by way of implementation of an intention or purpose, existing at the time of acquisition, of profit-making by sale, at least in the context of carrying on a business or carrying out a business operation or commercial transaction. In general, whether a profit from an isolated transaction is income according to ordinary concepts depends very much on the individual circumstances of the case. Matters listed in TR 92/3, which are relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction include: · 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 that property and · the timing of the transaction or the various steps in the transaction. In your situation, the Commissioner is satisfied proceeds from the sale of your subdivision will not be those from an isolated business transaction and will not be assessable as ordinary income under section 6-5 of the ITAA 1997, for the following reasons: · You are currently involved as a director and employee of a company which undertakes business activities · You are not in the business of property development · Your intention when buying the property was to hold the property for long term purposes; it was not your intention to subdivide, develop and sell the property · The subdivision will be done by an experienced property developer engaged by you. Your level of involvement in the subdivision will lack the repetition and regularity of activities of a person conducting a business operation · You have no other business relating to property development; this is a one off transaction · The developer will subcontract with contractors, agents and consultants as the developer chooses · The developer will be responsible for the development costs and you will receive your share of the profit after the developer has extracted their agreed share · You do not intend to undertake any further property development. | Detailed Reasoning - Treatment of individual subdivided blocks: When the land is subdivided, the effect of the subdivision is that each of the subdivided blocks is considered a new asset for CGT purposes under section 112-25 of the ITAA 1997. For example if a block of land is subdivided into 3 separate blocks, each of those blocks is a new asset. However, the splitting or change is not a CGT event. It is considered that the effect of registering separate new titles under the subdivision is to divide the original land parcel into two or more assets (the subdivided blocks). The subdivided blocks are then treated as separate assets under the capital gains provisions. They are taken to have been acquired by the owner of the original parcel when that original parcel was acquired (refer to Taxation Determination TD 97/3). TD 97/3 expresses the view that the disposal of a subdivided block is treated as the disposal of an asset in its own right, and not as a disposal of part of an asset (the original land parcel). In this case, the original asset (the whole of land) will be effectively transformed into new assets for CGT purposes if the planned subdivision will proceed. The new subdivided blocks consisting of that part of the land being used in the earthworks business by you are considered active assets for the purposes of section 152-40 of the ITAA 1997. In the circumstances, the conditions in paragraph 152-40(1)(a) of the ITAA 1997 are taken to be satisfied. However, the new subdivided blocks which consist of the vacant part of the land (being new assets for CGT purposes) are considered not active assets for the purposes of section 152-40 of the ITAA 1997. In the circumstances, the new subdivided blocks have never been used or held ready for use in the business by you. Therefore, the conditions in subsection 152-40(1) of the ITAA 1997 are not satisfied. Accordingly, when the land is subdivided and the new subdivided blocks which consist of the vacant land are sold, the new blocks will not satisfy the active asset test in section 152-35 of the ITAA 1997. | Detailed Reasoning - Conclusion: In summary, you will not be in the business of land development as you will not be involved in the day to day management of the subdivision project. Consequently the subdivided blocks will not constitute trading stock. You had no profit making purpose at the time you acquired the property, and the subsequent transactions will not have the character of business operations or commercial transactions as far as your involvement is concerned. There is no indication that your subdivisional activities will become a separate business operation or commercial transaction, or that you will be carrying on or carrying out a profit making undertaking or plan. The proceeds are therefore not ordinary income and not assessable under sections 6-5 and 15-15, or any other income tax provision, of the ITAA 1997. The proceeds represent a mere realisation of capital assets, which will fall for consideration under the CGT provisions in Part 3-1 of the ITAA 1997. Lastly, when the land is subdivided and the new subdivided blocks which consist of the vacant land are sold, the new blocks will not satisfy the active asset test in section 152-35 of the ITAA 1997.

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