Private ruling: Income vs Capital
Published: November 2013
Ruling period: Year ending 30 June 2013 | Year ending 30 June 2014 | Year ending 30 June 2015 | Year ending 30 June 2016
Date scheme commenced: 1 July 2012

Ruling: Q1: Is the subdivision and sale of the lots of land a mere realisation of a capital asset, therefore, profits made will not be assessable income under section 6-5 or section 15-5 of the Income Tax Assessment Act 1997 (ITAA 1997)? | A1: Yes.

Relevant facts and circumstances: Background On Month 19XX, the Taxpayer acquired an interest in a large block of land under a lease in perpetuity from the State Government. The land consists of two titles, one of around X hectares and the other of around Y hectares. The larger land is bounded by a river and has a public road traversing through it. In 200X, the Taxpayer was given the opportunity by the State Government to purchase the land outright. The Taxpayer accepted this offer and purchased the freehold interest. Livestock Business Since the acquired interest of the land in 19XX, the Taxpayer has used the land for the rearing of livestock either for sale to outside parties or for supply to an associated business carried on by the Taxpayer and their family. Over the past few years, due to a combination of the continued drought and increasing age, the Taxpayer has gradually scaled down their livestock rearing activities. In 200Y, the Taxpayer also discontinued the business operations but continued to use the land for rearing/grazing livestock. However, the number of livestock run on the land has been quite limited mainly because of the prolonged drought experienced in the region. Subdivision and Sale Due to the gradual scaled down of the livestock rearing activities and age, the Taxpayer has decided to dispose of the land to provide funds for their retirement. The Taxpayer has already sold the X hectares block of land. As the larger block of land which comprises around X hectares has a road running through it, it is separated into two parcel of land, the smaller parcel and the larger parcel of land. As the smaller parcel of land is isolated from the larger parcel of land due to the public road and also fronts the river, the Taxpayer has been advised that it would be difficult to sell this lot as farming land. Therefore, the most advantageous way to sell this lot is to subdivide it into 'lifestyle' lots. In order to do this, the Taxpayer requested the local Council to rezone this land as Large Lot Rural Residential which has been approved. The Taxpayer will submit a development application with the Council. The application will request the larger parcel of land to obtain its own title as farm land and also to subdivide the smaller parcel of land into X vacant lots. The X vacant lots will be zoned as Large Lot Rural Residential, Y of them will range in size from X to Y hectares per lot and the remaining lot will be a large vacant lot. The smaller parcel of land is likely to be subdivided and released for sale in two stages. It is expected that the first stage will release the smaller vacant lots, whilst the second stage will release the remaining large vacant lot. The Taxpayer has no interest in developing the land any more than is required to be able to sell the land as vacant lots. Accordingly, the works associated with the subdivision will be strictly limited to that mandated by the local Council as the minimum required for sale. As all proposed lots are accessible by the public road, no road, gutters or driveways are required to be provided. The works required are for each allotment to be connected to electricity, water mains and sewerage treatment plant. The electrical works required are minimal as there is already electricity running along the public road, hence all that is required is for transformers to be put in place for each proposed lot. The Taxpayer will engage other parties to carry out the relevant work. The Taxpayer recently secured a buyer for the larger parcel of land. If the sale is able to proceed early enough to allow the proceeds to be received, the Taxpayer will have sufficient funds to pay for the estimated subdivision costs. Otherwise, the Taxpayer may need to borrow funds for a short time to finance part of all of the subdivision costs for the period until such proceeds are received. In relation to the proposed subdivision, the Taxpayer will have no business organisation, no manager, no office, no secretary or letterhead for the subdivision activities. The Taxpayer will not market or sell the lots, but will engage a local real estate agency to market and sell the vacant lots. The Taxpayer has not obtained any valuation to estimates the land values and any information was only limited to their discussions with their real estate agent. The agent also further advised and suggested that the smaller parcel of land would be more valuable if rezoned and capable for a use other than farming. The Taxpayer also has no prior experience subdividing and selling land.

Relevant legislative provisions: · Income Tax Assessment Act 1997 , section 6-5 | · Income Tax Assessment Act 1997 , section 15-5 | · Income Tax Assessment Act 1997 , subsection 995-1(1)

Reasons for decision: Summary: The subdivision and sale of the lots of land is considered to be a mere realisation of a capital asset, therefore, profits made will not be assessable income under section 6-5 or section 15-5 of the Income Tax Assessment Act 1997 (ITAA 1997). | Detailed Reasoning - Detailed reasoning: Section 6-5 of the Income Tax Assessment Act 1997 (ITAA 1997) states that a taxpayer's assessable income includes income according to ordinary concepts, referred to as ordinary income. Ordinary income includes revenue derived from the carrying on of a business. An amount which is not assessable under section 6-5 of the ITAA 1997 as ordinary income may however be assessable under section 15-15 of the ITAA 1997, if the profit or gain arises from the carrying on or carrying out of a profit making undertaking or plan. | Detailed Reasoning - Conducting a business?: Subsection 995-1(1) of the ITAA 1997 defines 'business' to include 'any profession, trade, employment, vocation or calling, but does not include occupation as an employee'. However, this definition does not provide any guidance for determining whether the nature, extent and manner of undertaking those activities amount to the carrying on of a business. For this purpose it is necessary to turn to case law. The Commissioner's view about carrying on a business is found in Taxation Ruling TR 97/11 Income tax: am I carrying on a business of primary production? (TR 97/11). Whilst TR 97/11 is about carrying on a business of primary production, the indicators in TR 97/11, which have been developed by the courts of law, are used for all cases to determine whether activities constitute the carrying of a business. Paragraph 13 identified these indicators: · 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 manger 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. TR 97/11 further states that when considering whether a person is carrying on a business, all of the above indicators must be weighed up. However, in doing so, equal weighting may not be given to each indicator. Whether a business is carried on depends on the general impression gained and whether it has a commercial flavor or character. The weighting given to each indicator may vary from case to case. The Taxpayer obtained and used the land for their rearing of livestock business since 19XX. The taxpayer had never been in the business of land development or subdivision and the main reason of the sale arrangement are that the Taxpayer can no longer effectively continue their livestock business due to continued drought and increasing age. Therefore, to prepare for retirement, the Taxpayer plans to conduct a one-off transaction to sell their land. As they are not experienced in subdivision of land, they do not plan to have any active involvement into this transaction, but rather, rely on experts to complete the required work, advertising and eventual sale. The Taxpayer will most likely make a profit on the sale of the subdivided lots, but it does not indicate they have entered into this transaction for a profit making purpose. More importantly, the activity will only be a one-off transaction and it is rather small in scale when compared to business in the land development industry. In addition, the Taxpayer clearly has no intention to start a business in land development and is simply trying to wind up his assets before retirement. Specifically, in McCorkell v. FC of T (1998) 39 ATR 1112; 98 ATC 2199, the Court decided that the proceeds of the sale of subdivided land which the taxpayer previously used in his orchard activities did not constitute assessable income as the taxpayer was not carrying on a business of subdividing and selling land. In this case, the taxpayer had no other family member to continue the orchard business and was ready for retirement, therefore, applied and was issued a permit for subdivision of part of the land. Some of the relevant factors the Court took into consideration included the following: · the taxpayer had no active involvement in planning and contracting work for the subdivision or in selling the blocks; · the taxpayer relied on the surveyor and the engineer to carry out the work required and relied on two real estate agents to conduct the sales; · the taxpayer did not contract or deal with contractors or purchasers and had no business office or letterhead; · the taxpayer had no involvement in advertising or promoting the sale of the land; · the work carried out in developing the subdivisions were no more than what was necessary to secure approval of the authorities and enhance the presentation of the individual allotments for sale. Similarly, the Taxpayer has no active involvement in the subdivision or in selling the land as they rely on the real estate agents and other parties to complete the work required. The Taxpayer does not have a business office or letterhead for the sale of their land and the works associated with the subdivision will be strictly limited to that mandated by the local Council as the minimum required for sale. Therefore, it is considered that the Taxpayer is not carrying on a business of land development or subdivision of land. Accordingly, the proceeds from the sale of the subdivided lots are not considered to be ordinary income under section 6-5 of ITAA 1997. | Detailed Reasoning - Carrying on or carrying out of a profit making undertaking or plan: An isolated transaction refers to those transactions outside the ordinary course of business of a taxpayer carrying on a business. The Taxpayer's main business activity is farming and so the subdivision of farm land is outside the ordinary course of his business activities and therefore considered to be an isolated transaction. Paragraph 6 of the Taxation Ruling TR 92/3: whether profits on isolated transactions are income (TR 92/3) states that profit from an isolated transaction will generally be income when: a) the intention or purpose of the taxpayer in entering into the profit-making transaction or operation was to make a profit or gain; and b) the transaction or operation was entered into, and the profit was made, in carrying out a business operation or commercial transaction Taxpayer's intention or purpose Paragraph 8 and 9 of TR 92/3 states the following in relation to taxpayer's intention or purpose: 8. It is not necessary that the intention or purpose of profit-making be the sole or dominant intention or purpose for entering into the transaction. It is sufficient if profit-making is a significant purpose. 9. The taxpayer must have the requisite purpose at the time of entering into the relevant transaction or operation. If a transaction or operation involves the sale of property, it is usually, but not always, necessary that the taxpayer has the purpose of profit-making at the time of acquiring the property. Initially, the Taxpayer acquired an interest in the land under a lease in perpetuity from the State Government in 19XX. Since then, the Taxpayer has used the land for rearing of livestock for their business and rearing of livestock business. Although the business was discontinued in 200Y and the rearing of livestock activities has ceased for several years due to prolonged drought experience in the region, the Taxpayer has continued to try to re-start the rearing of livestock activities. Therefore, it is evident that the land was acquired with the intention for it to be used for the rearing of livestock and was used for that purpose. Therefore, it is considered that Taxpayer did not have any profit making intention at the time of acquisition. As discussed before, it is usually necessary that the taxpayer has the purpose of profit making of profit making at the time of acquiring the property, however, it has been demonstrated in the High Court decision in FC of T v. Whitfords Beach Pty Ltd (1982) 150 CLR 355; 82 ATC 4031; 12 ATR 692 that this is not always the case. If a taxpayer acquires an asset with the intention of using it for a certain purpose but later decide to use it in a business operation or commercial transaction, the profit from selling the property may still be income. As such, it is important to determine whether the Taxpayer's transaction is commercial in nature. Commercial transaction Paragraph 12 and 13 of the TR 92/3 states the following in relation to whether a transaction is considered to be a commercial transaction: 12. For a transaction to be characterised as a business operation or a commercial transaction, it is sufficient if the transaction is business or commercial in character. 13. Some matters which may be relevant in considering whether an isolated transaction amounts to a business operation or commercial transaction are the following: (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 additional to the above general factors, paragraph 265 of the Miscellaneous Taxation Ruling MT 2006/1 (MT 2006/1) provides a list of specific factors relevant to real property and development. If several of these factors are present it may be an indication that the activities are an adventure or concern in the nature of trade as opposed to the mere realisation of a capital asset. These factors are: · there is a change of purpose for which the land is held; · additional land is acquired to be added 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. As discussed before, the Taxpayer has used the land as farming land since 19XX for the rearing of livestock to sell to an associated business or outside parties. Since 19XX, the Taxpayer has only operated the business of rearing livestock and the specific business under the same ABN. Despite prolonged drought experienced in the region where the rearing of livestock activities stopped for several years, the Taxpayer never used the land for other purposes. The Taxpayer has continued to re-start the rearing of livestock business as the condition improved. In relation to the subdivision of the land, the Taxpayer is not starting a business organisation with office and letterhead and the work associated with the subdivision will be strictly limited to what is necessary to secure council approval. The Taxpayer is only planning to borrow funds for a short period of time to finance the subdivision costs if the other part of the land cannot be sold within time. Therefore, after considering the factors stated in TR 92/3 and MT 2006/1, the Taxpayer's activities are not considered to be commercial in nature. In addition, the Taxpayer's situation is quite similar to a recent court case Casimaty v FC of T 97 ATC 5153; (1997) 151 ALR 242; 37 ATR 358 (Casimaty) where the court considered the subdivision and sale of farming land. In this case, the taxpayer acquired a farming property from his father. The next year, the taxpayer purchased more land on which he erected on a homestead. For the next 20 years, the taxpayer conducted a farming business on the property, but because of growing debt and ill health, the taxpayer had to subdivide and sell off a large part of the property. In all, there were eight separate subdivisions and most of them required the taxpayer to construct one or more roads, provide water and sewerage facilities and to fence all boundaries. Although the subdivisions were numerous and ultimately were a large part of the original property, the court decided that the sales from the subdivisions occurred as part of the mere realisation of a capital asset. The decision was primarily influenced by the fact that the taxpayer acquired and continued to use the property as a farm and a residence. The court said that apart from the activities necessarily undertaken to obtain approval for the subdivision, there was nothing to suggest a change in the purpose for which the property was acquired. Also the land was sold as vacant lots and the taxpayer did not construct houses, provide internal fencing or make additional improvements. Similarly, in the current scenario, the Taxpayer acquired and continued to use the land for its rearing of livestock business since 19XX. Although the farming activities have ceased for a few years during the drought, the Taxpayer did not use the land for other purposes and continued to try to re-start their farming activities a several years before they now decided to sell the land due to continued drought and increasing age. Similar the Casimaty case, the Taxpayer is only going to undertake activities necessarily to obtain Council's approval rather than constructing house or making additional improvements. Therefore, the subdivision and sale of the land by the Taxpayer is considered to be a mere realisation of a capital asset. In conclusion, the Taxpayer is not carrying on a profit-making undertaking, therefore, any profit arising from the realisation of this isolated transaction will not be assessable under section 15-15 of ITAA 1997.